It’s Very Unlikely That We’ll See a 10% Correction Over the Next Month

It’s one of the funniest phrases in the markets…

No matter how many times it’s proven false, people will always believe…

This time is different.

Our psychology leads us to believe that our opinions are special, that the assets we’ve chosen to buy are special, and that this moment in time is special.

We often believe that this time we will beat the odds… because we have a gut feeling that this time is different.

But this time is almost never different. Instead, it’s a heck of a lot like every other time…

For example, on July 11, 2016 – the day that the benchmark S&P 500 Index hit a new all-time high for the first time in more than a year – we ran a historical study that looked at similar highs from the past. Our conclusion: “There’s a good chance we’ll see the stock market rise by 14% over the next 12 months.”

At the time, readers found this hard to believe. But 12 months later, the S&P 500 was 13.5% higher.

On September 28, 2016, we ran another study with extremely bullish results. The average one-year return in the past was 14.9%. So we said, “It’s time to be more bullish than usual… not bearish.”

Three months later, we followed up. The market was on track for the 14.9% gain. But we went further. We said…

If this signal works out as it has in the past… the S&P 500 could still climb 10.4% in the next nine months. That would put the index at nearly 2,500 by September.

Fast-forward to September this year… That month, for the first time, the S&P 500 closed above 2,500.

In each instance above, this time was strikingly similar to the past.

More recently, in mid-August, we ran a study based on the Volatility Index (or “VIX”). The S&P 500 had recently dropped more than 1% on two different days… And lots of folks were turning bearish. But between those two drops, the VIX closed with a reading below 12, signaling low volatility.

Since 1991, the VIX had closed below 12 more than 650 times. And in the one-month periods that followed those sub-12 closes, the worst drawdown in stocks was 5.9%. (A drawdown is the most an asset drops during a given time frame, even if it recovers before the end of that period.)

Drawdowns of 5% or more happened only 1.7% of the time. And 72% of the time, the one-month returns were positive. This made it easy for us to say, “The chances of a [10%] correction are slim.”

We did see a small 1.7% drawdown following the VIX’s sub-12 close in August. But at the one-month mark, stocks were 1.3% higher.

That “this time” wasn’t different, either.

Why do I bring all this up now?

Well for one, the VIX is back below 12 as I write. So everything we said in August is just as true today.

If we believe that this time is similar to the past, there’s about a 72% chance that stocks will be higher one month from now (using Friday’s closing price)… Meanwhile, there’s only about a 1.7% chance that stocks will fall by 5% or more over the next month. And in the month following more than 650 VIX readings below 12, the S&P 500 has never dropped more than 5.9%.

So it’s very unlikely that we’ll see a 10% correction over the next month… or even a pullback of 5%.

I laugh whenever I hear anyone use the phrase “this time is different.” It’s common enough. And people even use it with irony, knowing that this time is almost never different. But they believe it anyway.

If you ever find yourself betting that this time is different, think long and hard. Fear may be holding you back… And you may be missing out on a great opportunity. Over the course of your investing career, you could miss out on dozens, or hundreds of them.

That doesn’t mean you should be reckless, of course. Always look for good opportunities to hedge your bets. Use stop losses, intelligent position sizing, and asset allocation.

But keep in mind… this time is almost never different.

Good trading,

Ben Morris

Source: Daily Wealth