Fear is an almost uncontrollable emotion. And when you combine that with financial anxiety, it typically results in predictable fashion - a "throw the baby out with the bath water" selling event. But the good news is that, once the masses grow fearful enough, stock markets rally. After all, those who decide they can take no more financial pain sell.... and then there's only one thing left to do - buy back in. Those buying at the bottom tend to be professionals, which are much stronger hands than retail traders. Extreme fear and panic lead to MAJOR market bottoms. As long as that fear remains, we tend to trend higher. Ever heard of Wall Street "climbing the wall of worry?" Let me show you a BIG PICTURE chart and then provide a few examples of what I'm referring to:
When fear is increasing rapidly and violently, like we saw in 2008 and earlier in 2020, stock prices collapse. High and rising volatility ($VIX), which I define as above 20, leads to violent selling. Market makers, void of unlimited capital, become matadors and simply wave their red capes at Wall Street as prices fall precipitously. When we reach extreme volatility - anything above 45 - that's when I begin to look for a major bottom. In my investing lifetime, 2008 and 2020 stand out as major bottoms formed off of extreme fear. We don't have a VIX reading in 1987, but I imagine it would have been well above 45.
The next phase after the extreme fear is important because the market rallies. So long as fear remains high, prices are discounted as tons of money simply rests on the sidelines or is invested in areas that benefit from fear - treasuries and gold. As fear unwinds and the VIX falls, money rotates back from treasuries and gold, and retail traders slowly begin to buy back into the rally. I've written a lot about 2008 and 2020, so let's look at how the VIX unwound in 2016 and 2018.
Let's start with 2016:
We had additional bouts of fear in 2016, but note that it keeps drifting lower and lower. And, as fear is defeated, stock prices rise.
Now check out 2018 into 2019 with the trade war:
In both cases, the huge spike in fear set the bottom in stock prices. As the fear worked its way lower and lower, stock prices turned higher and higher. It's this emotional phenomenon that helps to direct stock prices. In a secular bull market, which I'm convinced we're in, fear grows smaller and smaller after that initial spike. It's this dwindling of fear that inspires confidence so that future selloffs are contained. Now, let's look at where we are in the current VIX cycle:
Our biggest problem many times lies within our own heads. We allow the constant negativity to drive our investing beliefs. "The market can't go higher because of the trade war." "The market can't go higher because of COVID-19." "The market can't go higher because of the upcoming Presidential election." Yet what does the market do? It just keeps going higher. Welcome to a secular bull market.
On Monday, July 6th, at 4:30pm ET, I will be hosting my "2020 2nd Half Market Outlook" webinar. After everything we've been through, it's a great time and opportunity to pause and re-evaluate everything. I will be providing my market forecast based upon all the facts (charts), not the media's constant negativity. I'll look at our major indices, gold and other commodities, the U.S. dollar, best sectors and industry groups, key ChartLists, our Portfolio performance, sentiment..... and even provide my Top 5 Stocks for the second half of the year! For more information on how to join me, CLICK HERE!
Wishing everyone a happy and safe July 4th holiday!
Happy trading!
Tom
