Buying on the dip? You may want to think twice as the market weakens

Just when you thought it was safe to wade back into the equity waters, the surf looks to be getting choppy again.

The market rally really hit a wall in October, with the S&P 500 ($SPX) losing two percent on the month. True, securities never move in a straight line and consolidation and corrections are a natural and healthy part of a market healing itself after a nasty trauma like the one it suffered earlier this year.

But there are some spooky signs underpinning the recent weakness that should give investors pause, says ever-bearish David Rosenberg, chief economist and strategist at Gluskin Sheff (and formerly of Merrill Lynch), who was probably as prescient as anyone on calling the collapse. As Rosie told clients Monday: "This is one dip you may want to avoid buying."
The market's torrid rally off the March bottom has been a low volume event, driven mostly by hedge funds, the high rollers on the trading desks at places like Goldman Sachs (GS) and Morgan Stanley (MS), and "flash trading," where computers execute thousands of orders a second to capture fractions of a penny in profit.

In other words, the rally has lacked conviction. But not so the sell-offs, which are higher volume affairs, and that's an ominous sign, Rosie says.

"It looks as though the hedge funds, pretty well the only buyers outside of the massive amount of short-covering in a rally populated by extremely low volume, are locking in their fortunate gains experienced since the government safeguarded the large banks last winter," Rosie wrote Monday.

Perhaps more distressing is the action on the Chicago Board Options Exchange Volatility Index, or VIX ($VIX). Known as the "investor fear gauge," the VIX went bonkers on Friday, surging 24 percent. "[That's the] largest single day increase since Oct. 22, 2008 and the highest level since July 8," Rosie wrote.

Even more alarming, the VIX has popped like that only 18 times going back to 1990, "and the sharp bounce in the past week -- up 48 percent since Oct. 22 -- is a really big deal, in our view," Rosie says.

In other words, the folks behind the market rally are starting to get pretty hinky. What that means: Don't be surprised if the wild market swings we experienced last week keep coming back in wave after nauseating wave.

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