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The dreaded v-word volatility has returned with a vengeance. How will you know when it is safe to tiptoe back into the markets?
While advisers caution against depending on any one measure or using them to time the market many have a favorite statistic or two that help point to future patterns.
Here are five to consider:
The indicator: "junk"-bond spreads.
What it measures: investors' willingness to lend to troubled companies.
What it is signaling: caution.
Typically, the yields of junk, or high-yield, bonds move in the opposite direction of stocks. The two have had a correlation of minus-0.9 during the past year, according to FactSet Research Systems (FDS) data. (A correlation of 1 means two assets move in lockstep; a correlation of minus-1 means they move in opposition).
During the market's late-August bounce, the benchmark junk-bond gauge, the BofA Merrill Lynch High Yield Master II index, remained about 6.3 percentage points greater than the yield of a 10-year Treasury, the widest spread since 2009. Anything over 6 percentage points is a sign of recession fears, says Keith Goddard, president of Capital Advisers Inc. in Tulsa, Okla.
Mr. Goddard says investors should tread carefully until the spread starts trending lower than the current 6.2%.
The indicator: options prices.
What it measures: the amount of risk traders expect.
What it is signaling: cautious optimism.
The Chicago Board Options Exchange Volatility Index has dropped 26% in two weeks. Other measures of volatility, however, remain at extremes.
The difference between the cost of a Standard & Poor's 500-stock index put option, which grants the right to sell the index at a preset price, and a put option at a 10% lower price hit a record high on Aug. 29, according to Barry Knapp, U.S. equity-portfolio strategist at Barclays Capital. That means investors are paying up for protection; when the cost drops, stocks could get a boost.
Until the cost of insurance drops, investors should remain cautious. "This is indicative of a very nervous market," Mr. Knapp says. "When demand for insurance starts to wane, it should help propel equities higher."
The indicator: correlation.
What it measures: stocks moving in sync.
What it is signaling: cautious optimism.
The 50-day correlation between the S&P 500 and the underlying stocks in the index reached 0.85 on Monday, the highest since Birinyi Associates Inc. began tracking the data in 1980.
When the measure gets to extreme levels, it tends to signal a turnaround. For instance, on July 7, 2010, realized correlation hit a then-record 0.81. The S&P rose 34% during the next 12 months.
That doesn't mean the ride won't be bumpy. "Extreme readings tend to mark lows in the market," says Jeffrey Rubin, head of research at Birinyi Associates. "But I would be surprised if the market didn't have a big one- or two-day selloff in the next few months."
The indicator: euro "basis swaps."
What it measures: how much a financial institution pays to exchange euro-denominated debt for debt denominated in dollars.
What it is signaling: danger.
Investors remain concerned that the euro zone's weakest members will default on their debt and take down the Continent's banking system.
How will you know the danger has passed? Watch euro basis swaps, a financial derivative that allows two firms to exchange floating-rate debt denominated in euros for dollar-denominated debt, says Aneta Markowska, an economist at Soci t G n rale.
Right now, a three-month euro-dollar basis swap is trading at about 0.8%, the highest since the financial crisis.
There isn't a simple way for retail investors to track basis-swaps. An alternative: The difference between the rate on the German three-month Treasury bill and Euribor, the London Interbank Offer Rate priced in euros. Right now, the spread is wider than 1 percentage point, the most since 2009.
"I'd like to see [spreads] get back to where they were at the start of the year," Ms. Markowska says.
The indicator: fund flows.
What it measures: turns in investor sentiment.
What it is signaling: cautious optimism.
Flows demonstrate whether investors are acting on their fears, says Tobias Levkovich, chief U.S. equity strategist at Citigroup (C) Inc.
During the week of Aug. 10, investors withdrew $23.5 billion from domestic stock funds, the most since October 2008, according to the Investment Company Institute, a fund company trade group. "It's a lot of money coming out in one shot," Mr. Levkovich says.
Such extremes often are a sign that the market is nearing a turn, Mr. Levkovich says. Withdrawals have slowed already; outflows were just $2.6 billion for the week ended Aug. 24.
"We're not getting a clear signal yet," Mr. Levkovich says. "But I'm willing to buy into this."
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