It has been a chaotic couple of weeks in America…
Nine days ago, former President Donald Trump narrowly escaped an assassination attempt.
And on Thursday, top Democrats suggested that President Joe Biden might resign from his reelection campaign within the week.
What’s more, both men recently floated policies that could hurt the artificial-intelligence boom that’s fueling the current bull market…
On Tuesday, Biden proposed placing the harshest possible sanctions on Chinese chip production. This policy would effectively put a leash on all foreign-made products that use American tech. These restrictions could eventually end up crashing the chip supply chain.
And in an interview that same day, Trump declined to answer whether he would defend Taiwan – the island nation where most U.S. chips are produced. So if the nation were invaded by China, there’s a chance Trump would let the chip industry suffer rather than join a conflict.
In short, the sands of U.S. politics are shifting… and the turmoil is weighing on stocks.
The S&P 500 Index fell 2% from July 16 to 18. The tech-heavy Nasdaq Composite Index fell 2.6% in the same period.
The “scared money” environment is causing folks to sell their positions. And the sell-off led to a spike in one of the market’s most popular fear-based indicators.
But if history is any guide, this spooked market environment is no reason to cash out. In fact, now is the time to buy the dip…
Two months ago, the U.S. stock market was cruising along…
Stocks were hitting new all-time highs and trending higher. And based on the CBOE Volatility Index (“VIX”), traders expected the smooth sailings to continue.
The VIX is a real-time index that represents traders’ expectations for near-term price changes in the S&P 500. In the simplest terms, it tells us how much investors expect prices to move over the next 30 days.
On May 21, the VIX hit its lowest level since 2019… reflecting extremely low bets on volatility.
But last week, the VIX shifted gears. On Wednesday, it rose 9.8%. And on Thursday, it rose another 10%.
These are big leaps for the VIX – especially compared to the calm we saw just a few months ago.
The move also broke the VIX out of a long-term downtrend. We can see this break from the trend using the VIX’s 200-day moving average (200-DMA).
A 200-DMA is exactly what it sounds like. This indicator shows a rolling average of the past 200 days of prices. It removes the noise of daily price moves and lets us see the overall price trend instead.
By plotting the VIX against its moving average, we can see the index buck its long-term downtrend. Take a look…
This big leap tells us fear is back in the market. The calm we experienced two months ago has been pierced… and traders are once again back on high alert.
But this doesn’t mean it’s time to sell. Fear is often a buying opportunity in disguise…
I wanted to see what similar spikes in the VIX implied for stocks in the past. So I tested 35 years of market history to find similar “jolts of fear” – periods where the VIX jumped 9% or more to break through its 200-DMA.
It’s rare for the VIX to make such an aggressive break with its trend. We’ve only seen similar moves on 2% of days since 1989. But these jolts aren’t usually a headwind to stocks. Check it out…
As it turns out, VIX surges like we saw last week have very little predictive power…
The test sample performed just as well as the broader market in almost every time frame. So the VIX soaring through its downtrend does not mean poor stock performance is ahead.
In fact, stocks only fell a year after the “jolt of fear” in 24% of cases since 1989. That means in nearly three out of four cases, traders’ fears simply failed to materialize.
So don’t take the recent surge in volatility as a reason to walk away from the table.
The market may be showing signs of fear, but you don’t have to. The data shows this bull market is still in full force. That’s why we want to be invested today.
Good investing,
Sean Michael Cummings
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Source: Daily Wealth