The S&P has fallen -3.09% from its peak and VIX has spiked. While today may be the “largest decline since December 2018”, it’s important to put today’s decline into perspective.
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Let’s determine the stock market’s most probable medium term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day.
The stock market’s decline today was not as significant as volatility’s spike.
VIX has spiked more than 50% over the past 2 days, while still under 20. From 1990 – present, this has only happened 1 other time:
While this may look scary, it’s important to remember that n=1 isn’t great for predictive purposes. Let’s loosen the parameters.
Here’s what happens next to the S&P when VIX spikes more than 30% over the past 2 days, while still closing below 20.
Here’s what happens next to VIX
As you can see, VIX is mostly bearish over the next 2 weeks. Perhaps VIX will spike another day or two, but going long VIX right now is not terrific from a risk:reward perspective.
Also, the S&P has a bullish lean over the next month.
We can use standard deviations instead of % changes to examine today’s volatility spike. Standard deviations are used in Bollinger Bands, a popular mean-reversion technical indicator.
VIX is now more than 3.5 standard deviations above its 20 day moving average.
Similar historical cases were slightly bullish for the S&P over the next month…
And mostly bearish for VIX.
Dow’s uptrend is broken?
The Dow closed below its 50 day moving average today for the first time in 75 days. That’s the end of a long uptrend.
While the stock market could fall more in the short term, it was mostly bullish for the S&P and Dow 6-9 months later.
The New York Fed creates a recession probability model by inverting the yield curve.
With the yield curve flattening, recession probability increases.
Here’s what happens next to the S&P when the NY Fed Recession Probability Model exceeds 27.4%
*We moved back each historical date by 1 year to account for when the data was released.
You can see that while this isn’t immediately bearish, it is a late-cycle sign.
- January 2006: bull market top and recession less than 2 years later
- July 2000: bull market peaked and recession in 9 months
- September 1998: bull market top 1.5 years later
- June 1989: recession and -20% big correction 1 year later
- November 1978: recession and -20% big correction less than 1.5 years later
- June 1973: already in a bear market and recession 6 months later
How uncommon is the stock market’s decline over the past 2 days?
The S&P sold off sharply over the past 2 days, which seems a little shocking to some traders considering the S&P was recently at an all-time high just a few days ago.
How uncommon is such a fast reversal?
Here’s what happens next to the S&P when it experiences 2 consecutive intraday declines that are greater than -1.5%, after it was within 1% of a 1 year high.
Seems to happen quite often. The selloff over the past 2 days is clearly connected with trade war news, but it seems that every-so-often some news does make the stock market fall quite rapidly from an all-time high.
The SKEW Index is a measure of potential risk in the financial markets. This indicator tends to mirror the S&P rather closely:
- A soaring stock market = rising financial risk (i.e. risk of a crash)
- A crashing stock market = falling financial risk (i.e. increasing probability of a rally)
While the S&P’s decline today is not exceptional, SKEW’s decline is quite exceptional. SKEW fell far below its lower Bollinger Band.
Here’s what happens next to the S&P when SKEW is more than -3 standard deviations below its 20 day moving average.
The 2 month forward returns are consistently bullish. Of particular interest are the 2007 and 2000 historical cases. Those historical cases occurred near the top of a bull market. Even then, the stock market still rallied over the next 2 months.
Here’s what happens next to the SKEW Index itself.
With the S&P making the first decent pullback since the December 2018 bottom, the % of S&P stocks above their 50 day moving averages has fallen.
This marks the end to a long streak.
Here’s what happens next to the S&P when the % of stocks above their 50 dma falls below its 200 day moving average for the first time in 2 months.
Forward returns over the next 3 months are mostly random, although there is a bullish lean over the next 6 months.
While the stock market has pulled back over the past few days, commodities have done much worse.
The CRB Commodities Index is now oversold.
Historically, commodities usually kept falling a little over the next 2 weeks.
Read Can the buy-the-dip crowd sustain this rally?
We don’t use our discretionary outlook for trading. We use our quantitative trading models because they are end-to-end systems that tell you how to trade ALL THE TIME, even when our discretionary outlook is mixed. When our discretionary outlook conflicts with our models, we always follow our models.
Here is our discretionary market outlook:
- The U.S. stock market’s long term risk:reward is no longer bullish. In a most optimistic scenario, the bull market probably has 1 year left. Long term risk:reward is more important than trying to predict exact tops and bottoms.
- The medium term direction (e.g. next 6-9 months) has a bullish lean.
- We don’t predict the short term because the short term is always extremely random, no matter how much conviction you think you have. Focus on the medium-long term.
Goldman Sachs’ Bull/Bear Indicator demonstrates that risk:reward does favor long term bears.
Members can see exactly how we’re trading the U.S. stock market right now based on our trading models.
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