Both the S&P 500 and Nasdaq 100 crashed by 3% on Monday.
The fear index, VIX $Cboe Volatility Index(VIX)$ , surged 65% to 38.45 from 23.39. This current VIX level of 38.45 is the highest since 2020.
Reasons for the Equity Market Rout
Unwinding of yen carry trade due to yen appreciation and interest rate hikes
Rising Middle East tensions
Recession indicator - Sahm Rule triggered
Weakening US labor market
Potential US-China tech war
Sector rotation triggered by impending rate cuts and Trump’s re-election odds
Growth scare due to lower earnings guidance
How Low Could the S&P 500 Go?
1) Based on 2022 Correction:
The S&P 500 experienced a maximum drawdown of 25.43% in 2022 due to recession fears, geopolitical tensions, and rising interest rates.
If history repeats, we may see the S&P 500 fall to 4,226.
2) Based on Historical US Election Year’s Max Drawdown:
Since 1948, the S&P 500 has had an average maximum drawdown of 13.22% in US presidential election years.
The S&P 500 has corrected by 8.49% to 5,186 from its 2024 high of 5,667. If history repeats, we may see the S&P 500 retreat to 4,917, representing a further drop of 5% from the current level.
3) Based on Technical Analysis:
Fibonacci extension shows that if the support level of 5,115 (61.8% Fibonacci level) for the S&P 500 is broken, the next major support is 4,805 (50% Fibonacci level).
Based on Fibonacci Extension, my strategy is to ‘Nibble at 5,115, Bite at 4,805, Gorge at 4,495’.
Note that 4,495 represents a major support level and appears attractive based on Fibonacci analysis, but it does not mean that S&P 500 will surely drop to the said price level.
I will revise the Fibonacci levels with new price developments.
How Long Might the Correction Last?
1) Based on Presidential Election Seasonality:
August is generally an up month, while September and October are typically down months during US presidential years.
We may see some rebound in August, followed by a resumption of the downtrend in September and October. The bottom could occur in September or October based on seasonality.
2) Based on Drastic VIX Movement:
Normally, VIX futures with longer-maturity trade higher than shorter-maturity VIX futures.
However, currently VIX futures with longer maturities are trading lower than those with shorter maturities, indicating that the S&P 500 is pricing in extreme near-term fear.
Typically, when the VIX spread (long-term minus short-term) is negative, it suggests that the S&P 500 is close to bottoming out.
Conclusion
The US equity market movement is anyone’s guess now. Investors should pace their entry and not to shout ‘buy’ at every possible bottom.
In summary, I am short-term bearish but long-term bullish. My preferred strategy is ‘Nibble at 5,115, Bite at 4,805, Gorge at 4,495’.
The market is volatile and changing rapidly. I am prepared to revise my outlook based on major fundamental developments.
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