It looks like the sharp market decline could be “panic selling,” highlighting a significant surge in the CBOE Volatility Index (VIX), which jumped significantly (74%)—the second-largest increase on record. Historically, such substantial spikes in the VIX have been followed by market recoveries within a month, suggesting that the current downturn may be short-lived.
Supportive Federal Reserve Policy
Despite the Federal Reserve’s recent hawkish tone, indicating fewer rate cuts than previously anticipated, I mentioned before (yesterday) that the central bank remains fundamentally supportive of the markets.
I interpret the Federal Reserve’s stance as a slower, more measured approach, aligning with market expectations as reflected in the CME FedWatch tool. In my view, this does not undermine the strong market fundamentals. While the recent selloff appears driven by bearish sentiment interpreting the Fed’s position as shifting from dovish to hawkish, I believe this reflects an opportunistic attempt by bears to counter prevailing bullish sentiment. It’s important to note that a truly hawkish Federal Reserve would not be lowering rates, making this interpretation somewhat questionable in the current context.
Capitulation
The recent behavior (12/18/24) has a “capitulatory tone,” characterized by a 90% down day and a significant VIX spike. Such capitulation often signals a bottoming process, where widespread investor surrender can precede a market rebound. There is no guarantee this is a bottom. Time will tell.
In summary, I have interpreted the recent market volatility as a temporary reaction, with historical patterns and supportive monetary policy indicating potential for a rebound. I consider the current environment as an opportunity for those willing to take on larger potential volatility and potential losses.
Yesterday’s closing action
I describe yesterday’s market action as “buyers falling off the bid.” This is a situation where market makers are experiencing low incoming buy orders, so stocks drift lower. Notice the three large exchanges of the charts below; they are eerily similar. The good part about the action was that it was not accompanied by serious downside selling pressure. This tells me the buyers and market makers are not yet convinced the sellers are finished; they are taking a wait-and-see approach.
- Uncertainty in Volatility Trends: Although previous spikes in the VIX have often been followed by recoveries, there is no guarantee that historical precedents will hold in the present economic environment. Prolonged volatility could lead to extended market declines.
- Federal Reserve Policy Risks: The Federal Reserve’s hawkish tone may dampen investor confidence and economic activity more than anticipated, particularly if inflation remains persistent or economic growth slows unexpectedly.
- Capitulation Misinterpretation: While I see the recent capitulation as a signal of market bottoming, further external shocks, such as geopolitical tensions, earnings disappointments, or unexpected macroeconomic data, could trigger additional selloffs.
- Sector-Specific Risks: If your focus is on small- and mid-cap stocks that have taken a recent beating, they carry heightened risks, as these sectors are generally more volatile and susceptible to downturns during uncertain market conditions because of liquidity.
Risk
Investing in the stock market carries significant risks and may not be suitable for all investors. Stock prices are subject to market sentiment, which can create substantial volatility and lead to sudden and unpredictable price fluctuations, often to the downside. Current market conditions are heavily influenced by shifts in sentiment, making them particularly uncertain.
Past performance is not indicative of future results. Projections and forward-looking statements are inherently uncertain and subject to risks, and investors should approach them with caution.
Before making any investment decisions, thoroughly research individual companies and consult a financial advisor to evaluate whether an investment aligns with your financial objectives, risk tolerance, and investment time horizon. Be prepared for the possibility of significant losses, including the total loss of your investment.
This statement is for informational purposes only and does not constitute financial advice or a recommendation to buy or sell securities.
Investors should weigh these risks carefully and consider their own risk tolerance, portfolio diversification, and investment time horizon when acting on this analysis.