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Is The Worst Over For The Stock Market?

Apr. 05, 2018 3:12 PM ETDIA, QQQ, SPY, XIV16 Comments
Damir Tokic profile picture
Damir Tokic


  • The news-flow is likely to become more positive going into the US midterm elections.
  • Thus, the worst is likely behind us.
  • The double bottom 10% correction is a buying opportunity.

The pre-correction risks:

There were two major concerns for the major stock market indices (SPY) (QQQ) (DIA) in January of 2018:

  1. Based on historical PE ratio comparisons, the stock market was possibly overvalued. For example, the frequently referenced 10-Year CAPE ratio showed the extreme valuation at over 30 multiple, comparable only to the 2000 peak. Even the 12-month forward PE ratio was seriously elevated based on historical measures.
  2. Technically, the stock market charts went parabolic in January of 2018, with the monthly return of 7-8% for January alone.

Thus, the stock market was clearly in need of a "health correction", as it was unreasonable to expect the parabolic trend to continue, given the seriously extended valuations.

The correction trigger

The initial selling in February of 2018 was triggered by the expectations of a more aggressive Fed, given the rising inflationary fears. Specifically,

  1. The wage growth for January showed a 2.8% annual growth, which was higher than expected.
  2. The yields on 10Y Treasury Bonds, which were in a strong uptrend, approached the 3% level, and thus supported the rising inflation fears. Additionally, the rising bond yields challenged the stock market valuations based on the Fed model.

The initial sell-off

Low volatility was one of the key characteristics of the stock market uptrend since November of 2016, as measured by the VIX Index. As a result, shorting the VIX futures was one of the most popular trades during this period, or short volatility via ETFs. The initial sell-off caused the spike in the VIX Index, which caused the unwind of the short volatility trade. As a result, the blow-up in several volatility products such as (XIV) also caused the forced selling of stock market futures, and essentially caused the sharp 10% stock market correction.

The initial rebound

As the forced

This article was written by

Damir Tokic profile picture
Global-macro research. Proprietary trader. Holding a valid Series 3 license as a Commodity Trading Adviser, member of National Futures Association. Professor of Finance. Editor-in-Chief Journal of Corporate Accounting and Finance.

Analyst’s Disclosure: I am/we are long S&P500. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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