Looking for a drop in market volatility

It would seem that we may be headed for an extended rise in the stock market, especially if we see a drop in market volatility going into the end of this year and into next year. I saw an interesting blog posting on a site run by Tom McClellan, the son of Sherman McClellan the originator of the McClellan oscillator. In that article, McClellan predicted that we should see a drop in stock market volatility by examining the relationship to the 90-day Treasury bill offset forward by 24 months. Here's the link to the article, http://www.mcoscillator.com/learning_center/weekly_chart/year-end_vix_plunge_coming/

Anyway I decided to examine this hypothesis further, so I downloaded 10 years of Volatility and T-bill data and ran a regression analysis on the relationship. It turns out that when you compare T-bill and Volatility there is a negative correlation of -0.55 which basically means that they move opposite to each other. (See chart below) However when you offset the T-bill data forward by 24 months, the correlation becomes 0.63, which means that they move in the same direction about 63% of time and the R squared is .40 which says that 40% of the movement of the market volatility can be explained by the movement of the T-bill from 24 months ago. Now you might be wondering why this relationship exists in the market. The explanation that McClellan uses in his article is that there is a big time lag between when the Federal Reserve engages in a monetary easing policy and when the effect is reflected in the economy. This lag between the actual Fed easing and the effect on the economy has been well documented and generally accepted by most economists. If this turns out to be the case here then, going forward into the end of this year and into next year, we should expect to see a further decline and then stabilization of market volatility at relatively low levels, which bodes well for the stock market.

The stock market is headed back up

Looks like time to get back in for the next leg up in the market. The brief stock market pullback lasted just about a week or so and amounted to a 5% correction. With Ireland now having agreed to an EU-IMF bailout loan package it would appear that EU fear card is now off the table. That said, the US dollar looks ready to resume its downward move again which means that the risk trade is back on.

The recent batch of economic reading has shown an economy clearly on the mend and with the Fed still in an easing mode with QE2, all indications are that the stock market is headed higher from here. The 1,227 level on the S&P 500 has been a stubborn resistance point, but once it gets past that look out, 1,350-1,400 does not look out of reach.