Stock market volatility has significantly risen in October. Many are wondering if a collapse is right around the corner.
The media is in full fear mongering mode right now. The slow news cycle has brought the Ebola outbreak front and center.
While the medical community is telling us that an outbreak here in the US is not likely, the fear of an outbreak can cause an economic impact on our already unstable economy.
Investors are starting to worry that there will be a global economic impact caused by:
1) Aversion behavior in consumers.
2) Impacts to emerging economies where outbreaks may be more likely.
3) The international cost of aid for Ebola stricken countries.
4) Slowdown in international trade due to heightened screening processes at ports of entry.
Normally, the above scenarios would most likely not have a major impact on the markets –however, the impact to an over-leveraged market which is also facing a reduction in economic stimulus from the Fed, might be enough to change some of the longer term trends in the market.
Trends In US Equities Are Changing
Now is the time to look at the trends in the markets and look into opportunities if the markets do continue to decline.
Some of the longer term trends that have been in place for the past few years are starting to breakdown and change.
This is important because it is an indication that investors’ perceptions and expectations of the market and the economy are changing.
A few weeks ago I posted the following chart in my last market update, Will There Be A Stock Market Rally This Fall?:
In that article, I mentioned that the markets would continue to rise as long as this rising trend stayed in place.
Fast forward to today and we can see that those trend lines are breaking down:
While the longer, multi-year trend is still in place, the breakdown of the trend that has been in place since the start of 2013 is a concern.
Volatility Continues To Rise
As the 2013-2014 trend line breaks, volatility in the market is starting to significantly rise:
This rise, in combination with the breakdown of the 2013-2014 trend line in the S&P 500 index, may be an indication that higher market volatility is back.
Flight To Safety
We are also starting to see a “flight to safety”. Asset classes, like US Treasury Bonds, have been rising during this time:
iShares Barclays 20+ Yr Treas.Bond (ETF)
Leverage Is Still Too High
One chart that I have been posting for the past few years, tracks the rise in margin borrowing.
This is important to watch, since:
1) We are at extremely high levels of margin borrowing.
2) Higher volatility levels may lead to a reduction of margin borrowing.
3) A reduction in margin borrowing means leveraged investors will need to sell positions within their portfolios.
What We Are Doing In Our Portfolios
As most of the above indicators are flashing a “yellow light of caution”, our ARTAIS model has been moving out of equities and reallocating into cash. At this time, though, the model has not initiated any short/inverse positions.
Since our portfolios are adaptive to changing market cycles, we can quickly move back into equities if the market shrugs off the current breakdown in trends — or move into short/inverse positions to take advantage of any longer term market declines.
However, the high level of margin borrowing has me worried that investors will be quick to reduce the leverage within their portfolios if the short term trend declines further.
What Needs To Happen To Keep The Market Rising?
Fortunately, the market is still holding on to some important levels of support:
Additionally, the S&P 500 (SPX) is still trading above its 200 day moving average — an important trend that signals the difference between bull and bear cycles for many investors.
Another good sign for investors is oil prices continue to drop:
And inflation remains low:
This means that the Fed has some wiggle room if further poor market/economic data pops up. If the Fed changes its policy on its tapering program, equities may rally.
Conclusion – Is There A Stock Market Crash Ahead?
While my ARTAIS model is signaling a reallocation away from equities, a stock market crash is not imminent.
A few things, such as a break below the S&P 500 index’s support level and 200 day moving average need to occur first.
However, the break of the 2013-2014 trend does mean that I expect to see higher levels of volatility in the market.
Conservative investors may feel more comfortable reallocating away from equities for now…
Feel free to leave a comment below or you can reach out to me privately here.
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