The stock market has a mind of its own, so I never like to say that it MUST do one thing or another. But I'm firmly in the camp of this being a cyclical bear market, rather than a secular bear market. Historically, cyclical bear markets within secular bull markets tend to be devastating, but very short-term in duration. Most last 3-6 months and average falling in the 20%-30% range. Q4 2018 was a perfect example of a cyclical bear market.
High volatility ($VIX) is always associated with bear markets of any kind. As the VIX rises, we can throw out our technical indicators. Personally, I think they're useless in a fearful environment. We have to let the fear play out in the form of high VIX readings and elevated-equity only put call ratios ($CPCE). I wrote an article in my Trading Places blog a week ago, titled "When Volatility ($VIX) Is This High, Wait For The Kitchen Sink".
Thursday was the kitchen sink.
The VIX closed at 75, the 4th highest level since the VIX began in 1990. The three higher VIX readings all came during the financial crisis in October/November 2008. The CPCE hit 1.28 at Thursday's close, showing significantly more put options traded than calls. How did that rank in history? Second, trailing only the 1.35 recorded on March 17, 2008. Here's a chart showing what happens at extremely bearish sentiment readings:
Note the light red-dotted vertical lines. Those are where we've seen extremely bearish sentiment readings, which almost always coincide with significant S&P 500 bottoms. That's when the kitchen sink gets thrown in.
In October 2008, we saw the VIX close at 80, then do so again one month later. Therefore, I wouldn't rule out the possibility that we could see one more low. But I definitely would not be shocked if Thursday's low turns out to be THE low. My strategy is to buy the SPY and QQQ when we appear to be marking a highly volatile bottom. If I'm right, the SPY and QQQ will perform extremely well and rally quickly - just as we saw on Friday.
Because of all the puts traded the past few weeks and the record CPCE level on Thursday, there could be quite an opportunity next week as monthly March options expire. We have a webinar scheduled on Tuesday to discuss "max pain," which is the point at which in-the-money call premium equals in-the-money put premium. It alerted us to a major selloff as we approached February's option expiration, and it's currently giving us the opposite signal.
We'll be sending out registration information for that timely webinar to our EarningsBeats.com community early next week. To be included, and to receive our 3x per week EB Digest newsletter - which is free and discusses earnings and relative strength - simply provide us your name and email HERE.
Happy trading!
Tom
