The Market’s Recent “Shock Drop” Indicates the Stock Market’s Bottom for 2018 Is In

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Tony Dwyer, Canaccord Genuity’s chief market strategist reports his “shock drop indicator” demonstrates this year’s stock market low has already been reached.

Dwyer summarizes the shock drop indicator, a barometer of markets and human emotion, in a recent client note:

“As a reminder, a shock drop is a correction sharp enough to cause the 10 week rate of change (ROC) in the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) to spike to 125.  We found that, historically, every shock drop was followed by a bounce and then a nasty retest of the low as volatility began to decline.”

February 2018 is only the most recent example of a shock drop.

Stocks fell sharply in early February with the S&P 500 (SPX) and Dow Jones Industrial Average (DJIA) falling in excess of 10% from all time highs set in late January, displaying what has been widely recognized as a correction, as the VIX spiked.  In 1998, stocks soared to a new high following a retest of the low.  In both 2010 and 2011, stocks experienced another dip after the retest before climbing back up.  In each of these years, the low was in when the VIX rate of change dropped below zero and new peaks were observed less than four months later.  The historic market drop of 2008 differs because the drop occurred during a global financial crisis.

Dwyer sees no reason to change “what worked so well in analyzing a human nature driven shock drop.”  He further explains: “We found that when the 10 week VIX ROC spiked to 125 or above, and then dropped below zero, (1) the VIX dropped even further, (2) the SPX low was in, and (3) the SPX made a new high median 78 trading days later.”

What exactly is the human nature element?

Of episodes which do not shut down credit due to a yield curve inversion, Dwyer said “each intermediate term correction feels like the fundamental backdrop is at risk, only to ultimately realize that positive fundamental influences that drive our core thesis still exist.”  He contends “such extreme human nature reactions” should be expected only occasionally. Stable worldwide growth is just one of the core fundamental factors.  In addition, a pickup in capital spending, strong employment numbers giving a boost to median household income, and a push toward higher home ownership all point toward a solid base.

Economic foundations continue to be solid.

Dwyer seems unconcerned over the subdued reaction to earnings from Bank of America (BAC), JPMorgan Chase (JPM), and BlackRock (BK).  The longer term charts on the financials remain bullish.

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