I often liken stock market predictions to weather forecasting. A
meteorologist can tell you what the weather will be like tomorrow with a
very high degree of certainty. However, as the forecast is extended in
time, the accuracy diminishes. Trying to forecast what the weather
will be like anything more than a few weeks out, other than
incorporating the typical seasonal patterns is basically a crap-shoot.
The same holds true when using technical and even fundamental analysis
to forecast future prices in individual stocks or the stock market
although I do believe that the charts, combined with the study of the
business cycle and other macro-economics, do allow us to make
potentially accurate longer-term predictions.
When trading or investing, we can use all the resources at our
disposal to formulate scenarios that are likely to play out for months
and even years in the future with the goal of successfully aligning our
trades or investment portfolio according to that scenario. The key is
to be flexible and to continually analyze the data, both fundamental
(e,g.-economic data, earnings trends) and technical (charts) in order to
make any necessary adjustments to your plan as needed.
For months now, I have been making the case that the US equity
markets were setting up for a substantial decline and quite likely a new
bear market. I continually look for evidence that either reaffirms
or refutes that scenario. Yes, there
will always be enough evidence present to formulate a pretty decent
bullish case or bearish case at just about any point in time but what
ultimately determines who will be right and who will be wrong is how one
interprets the same data that is easily accessible to all.
With that being said, the chart below is something that I actually
covered at the end of the recent $SPX top holdings video. What this
chart illustrates, at least by my interpretation, is a blatant lack of
fear amongst market participants since the current market correction
began in mid September. There is an old adage that says stocks climb a wall of worry
and for the most part, that holds true.
Major market bottoms are
almost always formed when fear is rampant and it looks like the bottom
will never come. However, the same typically holds true for market tops
where instead of fear, complacency rules. This chart highlights all
similar market corrections over the last several years since the bull
market began back in March 2009. By similar, I am referring to
corrections similar in scope that followed substantial prices advances
AND began with the $VIX towards the bottom of it’s range.
As the chart shows, this has been by far the most muted response from
the $VIX on such a correction in the $SPX. In fact, the second most
muted reaction occurred on a nearly identical market correction that
occurred from 4/26/11 to 6/21/11. From there, prices rebounded sharply
for just over 1 week before plunging and sparking the most powerful
sell-off since the bull market began, the end result of complacency
combined with bearish technicals, exactly the conditions facing the
market today.
