DEFLATION--Are Markets Signaling The Dreaded Scenario?

Are the markets signaling DEFLATION ahead?  Japan is trying their high-risk experiment to inflate.  While their efforts seem to be working initially with the Yen collapsing and Japanese equity markets soaring, there is growing concern that their efforts would ultimately lead to failure.

I look at multiple markets, and I'm noticing a pattern that is eerily reflective of overall markets that is concerned about deflation ahead.  Gold prices plummeting is puzzling because usually precious metals perform well under periods of deflation.  We definitely need to keep an eye out for and be mindful of potential weakness in housing and real estate sector.  Strength in these sectors have been the foundation for prospects for improving US economy and reflation of assets prices.

Average Oil Futures Price Chart:  Oil prices plunging

JJC Chart: Copper Prices plunging

TLT Chart: Long-Term Bonds Rising

Corn Futures Chart:  Grain prices plunging

XLP Chart: Consumer Staples sector outperforming

XLV Chart:  Healthcare sector outperforming

Gold Futures Price Chart:  Gold prices plunging, but this is a
tricky one because gold prices usually outperforms in periods
of deflation

XHB Chart:  Definitely need to keep an eye on home

building sector because if US home prices start to fall, that

would signal really troubling times ahead.

IYR Price Chart:  The same goes for real estate sector.  Keep

an eye out for real estate sector weakness

VIX is Undervalued.

The S&P500 Index is moving into record highs and is showing very bullish action.  No way to say how high the equity market could go.  However, based on our proprietary volatility indicators, the momentum of realized volatility on the S&P500 Index is rising.  The S&P500 Index is also moving at a 13.55 realized volatility, while VIX currently is at 12.80.

The realized volatility indicator shows what an appropriate ATM IV of May options could be.  Since VIX on average has 12% premium over ATM IV levels, fair value of VIX should be around 15, regardless of whether the index is moving up or down.

The May VIX futures is trading now at 14.60, naturally at a premium over VIX, but 14% premium is also lower than the 18% premium on average, VIX futures trade with over 5-weeks to go before its expiration.

Executing a ratio call spread, selling the VXX May 19 call and buying 2x VXX May 21 call for under 0.40 debit wold be a good risk/reward strategy and gives you exposure to volatility over the next 2 weeks through big chunk of earnings season without too much risk.