When comparing selected forecasts made this time last year to actual results it seems like they must have been looking at completely different sets of data. Although there was a long list of economic worries that could sink the equity markets last year, with considerable help from the Federal Reserve the S&P 500 Index managed to end the year with the same upside momentum it showed in the first few days, closing up 29.6% for the year – a truly remarkable performance.

Reviewing both market and economic forecasts for 2013 reminds us this annual endeavor is at best just guesswork. Peter Drucker, the distinguished management consultant and author said:

“Trying to predict the future is like trying to drive down a country road at night with no lights while looking out the back window.”?

Market Review

S&P 500 Index?(SPX) ?Last week?we proposed that early signs of economic improvement could result in higher equity and commodity prices along with rising interest rates. With just two days of trading, it is too soon to say the weakness will continue especially since volume was low, perhaps due to bad weather, as some participants may have decided to take the rest of the week off. However, by the end of this week we should know if early signs of profit taking are likely to turn into an overdue correction.

CBOE Volatility Index??(VIX) After reaching a low of 11.69 Thursday December 26, VIX turned higher to close at 14.23 last Thursday before a slight decline Friday.

The table below shows the VIX cash compared to the next two futures contracts as well as our calculation of Larry McMillan’s day-weighted average between the first and second months.

010614VIX1

 

The day weighting applies 48% to January and 52% to February for an average premium of 5.32% shown above. Our alternative volume-weighted average between December and January, regularly found in the Options Data Analysis section on our homepage, is slightly lower at 4.72%. Last week, the premiums declined from 12.39% as the term structure began to flatten out once again indicating more hedging with VIX Futures thereby suggesting more caution.

VIX Options

With a current 30-day?Historical Volatility?of 80.61 and 63.00 using?Parkinson’s range method, the table below shows the Implied Volatility (IV) of the at-the-money VIX calls and puts using the futures prices based upon Friday’s closing option mid prices along with their respective month’s futures prices, since the options are priced from the tradable futures.?010614VIX2

 

The relatively low Implied Volatility Index Mean (IVXM) 56.11 is below both Historical Volatility measures for a .70 ratio and .89 using the range method to calculate Historical Volatility.

All of the Implied Volatilities along with the Historical Volatilities and Greeks for the VIX options based upon the futures prices are on our?Advanced Options?page, found by clicking on the “?market close” link shown near the top of the page.

US Dollar Index?(DX) ?After testing the lower end of its recent range on December 27, the dollar began reflecting strength commensurate with higher interest rates as excepted advancing back up toward resistance in the 81-81.50 area. A higher dollar along with higher interest rates could be an important influence on continuing sector rotation into cyclical stocks this year.

10-Year Treasury Notes?(TNX) yield 2.99% in an uptrend defined by an upward sloping trendline from the October 30 low of 2.47 and the December 18 low at 2.82. As long as rates stay above this trendline we assume the advance will continue, which should support the dollar and may even support higher selected commodity prices assuming they are reflecting expectations of improving economic conditions as we proposed in?Digest Issue 50?”Changing Picture.”

iShares Dow Jones Transportation Average Index?(IYT) The transports are important not only from a Dow Theory perspective, the oldest widely used market timing system, but also because they advance early in normal market cycles. Currently the close remains above the operative three point upward sloping trendline starting at the October 9 low of 114.49 and touching the December 12 low at 126.00 and the December 18 low at 126.59. The seasonal crude oil decline should add some further support.

NYSE McClellan Summation Index?The bulls should be encouraged by continuing breadth improvement last week as our favorite measure added another 127.81 points the previous week’s 192.99 advance. However, as we mentioned last week it is still much lower than it was May 17 when the NYSE Composite was lower creating a divergence. We will be watching to see if better economic conditions and expected outperformance by small capitalization stocks translates into better market breadth.

CBOE S&P 500 Skew Index?(SKEW) SKEW measures the purchase of out-of-the-money S&P 500 Index puts that require a very large downside move to profit from long put positions. An increase of this index indicates greater expectations for an extreme down move.

Although SKEW closed 2.26 points lower than the week before, it made a noticeable 12.69-point advance Friday suggesting more out-of-the-money put activity. However, Friday’s volume was light on a short holiday week with bad weather conditions so some market participants were not likely engaged. We should have a much better picture be the end of this full trading week.