Equity Bears Finally Take Control
After trending nicely for months, U.S. stocks finally succumbed to selling pressure. The S&P 500 Index ETF (SPY) is off its 52-week highs by about 7% after rebounding off Monday’s “baby out with bathwater” move lower. What’s behind the move? Political instability in the U.S., rising tensions in the Middle East, and most importantly, the “Yen Carry Trade.” Simply put, global investors have been borrowing Japanese Yen (where interest rates are low) and exchanging it for a high return in Australian dollars (where interest rates are high). However, interest rates changed over the past few weeks, and the trade unwound in a hurry, brutalizing the Japanese market and theglobal marketas a whole.
Whatever the cause of the correction, one thing is clear: a correction was due. In fact, until recently, the S&P 500 Index had been abnormally calm and was on one of its longest streaks ever without a 2% down day. Finally, we have seen a much-needed correction. Though volatility is unlikely to subside in the short term, three market extremes suggest that a big intermediate bottom may be around the corner.
VIX has 3rd Highest Spike in 30 Years
The VIX, also known as the Volatility Index, serves as a market gauge indicating the market’s sentiment towards volatility within a given month. Often dubbed the “fear gauge” or “fear index,” it tends to rise during market phases and decline when markets are stable. Volatility tends to spike during tense moments and “black swan” events but during normal times will downtrend and remain low during normal times. For this reason, investors most often use the VIX to hedge against unexpected market corrections.
The best way to use the VIX is to spot market bottoms. Because market bottoms are often an event rather than a process (like tops), an extreme reading in the VIX is one of the best indications that the worst is likely over. Earlier this month, the VIX spiked above $60 to print its third-highest reading in the past 30 years! Though the Nasdaq 100 Index ETF (QQQ) is in correction territory, down 12%, the VIX tells us that investors are panicking like the market is in a full-blown bear market. Only the Great Financial Crisis of 2008 and the COVID-induced panic of 2020 saw higher readings. Each of these spikes led to long-term bottoms.
Image Source: TradingView
“Extreme Fear” Sets in
The CNN Fear and Greed Index is a composite tool that combines seven different market gauges to provide investors with a sentiment reading between “extreme fear” and “extreme greed.” Earlier this week, the indicator flashed its most fearful levels since October 2023, the last major intermediate bottom in the market. Historically, the reward-to-risk ratio is favorable when the crowd is bearis,h like it is now.
Image Source: CNN
Seasonality
In the past two years, U.S. equities peaked in late July and bottomed in October. Will history repeat?
Bottom Line
It’s far too soon to assume that volatility will subside in the short-term. However, the market is flashing extremes that often coincide with long-term market bottoms.
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