Volatility Returns. Market Reverts to Low End of Uptrend. Stick to the Strategy.
By: Jeffrey A. Hirsch
February 08, 2018
The blame for this selloff has been placed on a plethora of circumstances. Last Friday’s employment report finally showed wages on the rise, which is good news for the economy, but it stoked inflation fears. Interest rates in turn moved a bit higher, also a positive sign of the U.S. economy’s improving condition, but this also spooked investors and traders that the Fed would speed up the rate tightening cycle, conveniently forgetting how historically low rates remain.
Unrestrained crypto currency trading and a tidal wave of Initial Coin Offerings (ICOs) has been compared to the 1999-2000 dotcom bubble IPO craze. A massive short cover in low volatility derivatives, especially inverse VIX Exchange-Traded Products (ETPs), driven by algorithmic trading programs has also been held responsible. Back in our November Outlook we warned, “This market is so robust at the moment that it will likely take some systemic market event. Perhaps it will be triggered by a run in the mushrooming ETF arena….
Market’s also notoriously like to test new Fed chairs and Jerome Powell was confirmed by the Senate on January 23 and sworn in and took office on Monday February 5 just as this selloff ensued. The continuing political battle of the federal budget and debt ceiling and the threat of another shutdown has also given the market jitters. The list goes on.
The past five days of large intraday market swings and declines has now delivered the long awaited first 10% correction at today’s close since the February 11, 2016 mini-bear-market bottom, nearly 2 years ago to the day.
But the bottom line is rather quite simple. This market got way ahead of itself in typical euphoric frenzy. This confluence of triggers and market rattling events appears to have swung the market pendulum firmly in the other direction in the near-term reverting equity prices to the low end of the uptrend. As you can see in the chart below, since just after the election in 2016 and the initial pop the S&P 500 has been trending higher in a sane uptrend channel. 
Then in January it spiked far above the upper end of that channel as investors piled into the market not wanting to miss out. At today’s close we have returned to the low of this uptrend channel. We still may dip below this low end of the channel, but there are a few encouraging technical readings. As we reached the low end of the channel at today’s close, the market may have formed a “W” 1-2-3 swing bottom with Tuesday’s intraday low. If we can clear the middle of the “W” high at point 2 (Wednesday’s intra-day high) and close above it that would be encouraging. In addition, the VIX was significantly lower at today’s low than it was at Tuesday’s low.
At times like these it is crucial to remember that emotion is our worst enemy and not to succumb to fear and greed and react hastily to current events. Stick to the strategy that has stood the test of time. Our January Indicator Trifecta came in positive this year reinforcing our bullish outlook from our Annual Forecast. And as you all know, February is the weak link in the Best Six Months and large January gains tend to correct or consolidate in February as they recently did in 2016, which was followed by a resumption of the rally. So let’s not make any rash moves and stay the course.