The stock market has become exciting again! After spending seven white-knuckle sessions below its 200-day simple moving average (SMA), the Dow Jones Industrial Average has rocketed back above this crucial level. Adding more drama to an already tense situation, the Dow has formed a "make or break" double top technical pattern just below its 50-day simple moving average. A breakout could easily mean a quick surge back to the all-time highs in the 27,000 zone, while a failure to break out will likely result in a test of support at the 200-day SMA.
Should the support break, there is no telling how far the market index will plunge. Just for perspective, it will take a death spiral into the 21,000 zone for pundits to say it's a bear market. Remember, it takes a 20% plus drop from the highs to trigger a bear market.
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So what does the future hold? Will we see an explosive rally to new all-time highs, a market crash, a flat line, or a slow move in either direction?
While I firmly believe the push higher will continue and perhaps even take out the highs, no one really knows for sure what the future may bring.
Here are 5 things you can expect since the plunge:
1. Volatility Will Remain High
After languishing for months, the October carnage resulted in the VIX index spiking higher. The index has since fallen back but remains above both its 50 and 200-day simple moving averages.
For those of you new to the game, the VIX represents the market's expectation of the next 30 days of volatility. It is created from the prices of S&P 500 options. Practically, the VIX represents the number of investors whose bias is stocks will plunge in value. The reason being is that they purchase puts to protect their position which is how the VIX is derived.
An interesting way to imagine the VIX is the S&P 500 upside down. When the VIX moves higher, the S&P 500 moves lower and vice versa. The VIX is called "the fear index" for a reason. The higher the fear in the market, the more traders hedge their positions with options, driving up the price of the options and therefore the cost of the VIX.
Since I expect the sharp moves in both directions to continue, volatility should remain relatively high. Remember, I am talking about severe steps in both directions so upside volatility will also be a significant factor moving further
2. Pessimism Becomes Optimism
Investors are a fickle bunch. October's plunge turned even the most ardent bulls pessimistic about the stock market. As it appears that a long-term bottom is in, I expect optimism to slowly return to the market. As confidence returns, it will be a self-fulfilling prophecy as it spreads across the economy lifting all ships once again.
What I have learned from the market is that investors can turn bearish much quicker than they turn back to bullish. This is due to the fear of loss being much greater than the greed of more significant gains. Any sharp market plunge will trigger widespread pessimism. It really seems that the bears come out of the woodwork with any market drop. However, it takes much longer for investors to regain confidence.
3. Rate Hikes Will Continue, But Do Not Fear
I have long held that it is not climbing interest rates that hurt the stock market but, rather, surprises. The Federal Reserve has made it abundantly clear that there will only be one more rate increase until the end of 2018 and the pace of increases will not increase.
Remember, rates have been slowly moving higher since 2015. Despite the change in policy, the stock market has continued to hit record high after record high, proving that it takes much more than gentle rate increases to derail a roaring bull market.
The only worry is if the Fed feels it must shock the economy with an extreme move in rates. All bets are off should this black swan-type event occur!
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4. White House Turmoil
There is no question that the turmoil in the White House will continue. The uncertainty will only lead to increased volatility in the financial markets. The great thing for investors is that the sell-offs caused by Trump are always short-lived, creating incredible buying opportunities.
Now that the House of Representatives has changed hands expect even more desperate measures by the present administration to retain control.
5. Chinese Tensions Will Diminish
I expect the Chinese trade war tensions to diminish significantly. In fact, it may become a vastly market favorable should Trump negotiate positively. With all his faults, Trump remains the master dealmaker, and I am very confident that he will be successful in ending the strain.
Risks To Consider: The above are my thoughts on what to expect into the end of 2018. No one knows what the future holds and anything can happen. Always invest wisely!
Action To Take: Use every market sell-off as a buying opportunity!