Is The Market Carnage Over Yet?

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by: Ironman at Political Calculations

From the end of trading on Friday, January 26, 2018, when it closed at its all time high of 2,872.87 to the market close on Tuesday, February 6, 2018, when it rebounded from the previous day's crash to close at 2,695.14, we estimate that the S&P 500 lost over $15.9 trillion of its market capitalization. Since that's a lot of money to have so suddenly evaporated over the last seven trading days, we imagine that a lot of investors are asking if Tuesday's rebound marks the end of the market carnage.

Nobody will know the answer for sure for some time yet, but we do see an intriguing possibility that it has. If we're right, and the sudden, sharp drop and highly volatile trajectory of stock prices has indeed all been part of a Lévy flight event, it may indeed be over except for some higher-than-typical levels of daily volatility, because it would appear that investors have completed shifting their forward-looking attention from the distant future quarter of 2018 Q4 all the way back to the current quarter of 2018 Q1, since such shifts in forward-looking focus are the drivers of this kind of volatility in our dividend futures-based model of how stock prices work.

Our alternative futures chart above updates and modifies the version we first presented back in the early hours of Monday, February 5, 2018. Let's talk through the updates:

  • The crash of stock prices from Friday, January 26, 2018, to Monday, February 5, 2018, has confirmed for us that our model's spaghetti chart-like projections of alternate trajectories that the S&P 500 might take assuming investors focus their forward-looking attention on specific future quarters is showing the effects of a new volatility echo, which runs in the period from February 7, 2018, through March 6, 2018. The echo effect is a consequence of our model's use of historical stock prices from 13 months, 12 months and 1 month earlier in time as the base reference points for its projections, where the echoes of past volatility affect its forecasting accuracy.
  • To get around that limitation, we've developed two new "red zone" forecasts using our "connect the dots" approach to dealing with the echoes of past volatility (in this case, from the one-month earlier period) on our model's projections. The first assumes that investors will keep their forward-looking attention on 2018 Q1 until the dust settles, which is represented by the solid red line box shown on the chart above. The second assumes that investors will shift their attention to the slightly more distant future quarter of 2018 Q2 sometime during the next four weeks, which is shown as the dashed red line box on the chart above.
  • Right now, the width of the red zone forecast boxes are shown with the same +/-3.0% margin of error range that we use for our standard forecasts, which assume "typical" levels of day-to-day stock price volatility. Given the recent outbreak of chaotic volatility, however, we might see stock prices move outside of those ranges without necessarily being the result of a definitive shift in the forward-looking focus of investors.
  • There's another issue that we're growing increasingly concerned with involving the dividend futures data that we used for our model's projections, which itself may provide for a unique investing opportunity. More on that soon!

We may not yet be at the end of the stock market chaos, but the possibility that we might be is pretty intriguing.