A powerful two-month rally for U.S. stocks has likely come to an end, market watchers say, with the so-called fear index signalling an upcoming bout of volatility.
Both the S&P 500 and the Dow Jones Industrial Average surged in October and November on the hopes of the first phase of a trade deal between the U.S. and China being reached. Over the past three trading days, however, the S&P 500 has shed most of its November gains as trade tensions once again appear to be fermenting.
On Friday, U.S. President Donald Trump signed a bill supporting human rights in Hong Kong and followed that up by announcing that he would restore tariffs on Brazilian and Argentinian steel due to allegations of currency manipulation. Worse for investors, on Tuesday, Trump suggested a trade deal with China may have to wait until after the election and reports suggested he would follow through on additional tariffs he promised to levy on China this month.
The classic signs pointing to investor skittishness are all there: The stock market is selling off, the price of gold has surged back above US$1,480 per ounce after trailing off in November and the fear-gauging CBOE Volatility Index has rallied 27 per cent in the past three days. According to Larry Williams, a trader and author who maps out the VIX, this rally has the potential to endure through the winter, which likely means that the market is set to suffer.
“Clearly it looks like we’re going to have some tough sledding ahead here to the downside,” Williams said of the U.S. markets, which didn’t need Trump’s trade rhetoric to begin trending downward. “Regardless of what the news is, the market is set to have a decline here.”
Williams has charted out his VIX projections through to April and has the index moving upward with some ebbs and flows until March, where it’s set to peak at about 24 points. This doesn’t mean a recession is upcoming, or even a bear market, he says, but a period of sustained weakness and downward pressure is possible.
Projecting out the VIX allows a trader like Williams to measure both cycles and emotions — and if he knows which way the market may be leaning, he can plan accordingly. And he has. He’s taken his portfolio into cash and only remaining long on precious metals such as gold and silver while waiting for a re-entry point.
Clearly it looks like we’re going to have some tough sledding ahead here to the downside
Larry Williams, trader and VIX mapper
The S&P 500 was long overdue for a correction, according to Sven Henrich, founder and lead market strategist at NorthmanTrader.
The U.S. Federal Reserve has been compressing volatility and the VIX through its monetary policy and daily injections of US$120 billion in the repo market to address a lack of liquidity. This was the Fed’s way of stopping a recession, he said.
“The market structure significantly changed from that point on,” said Henrich.
The U.S. markets hit all-time highs on multiple occasions over the past few months on the backs of the Fed’s injected liquidity and “dozens of trade optimism rallies that haven’t produced anything close to a trade deal,” Henrich said.
Market volatility could only be held down for so long, Henrich said, before it popped back up and if the S&P 500 doesn’t stabilize from here, the VIX index could easily trend toward 21 to 24 points. That could mean further downward pressure on the S&P 500, especially if it crosses specific technical levels.
Henrich will be watching how the benchmark U.S. index performs over the next weeks as its slide approaches the 3,028-point level, where it peaked in July. There is a level of support at that point, and should it fail to hold, the markets could be primed for deep losses.
“If you were to drop and stay below 3,028, I think you’ve got a massive problem in this market,” Henrich said. “If we drop below that and stay below that, good luck, because there’s a whole array of lower gaps to fill.”
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That might leave investors with but one option.
“Hug your stocks,” Henrich said.