What will the market do next? Some traders believe that the current market trend will reverse course and that the Dow Jones Industrial Average (DJIA) or the S&P 500 (SPX) will soon decline by more than 10%. In an attempt to profit from such a short-term market dip, these traders might load up on sell orders (bets) that the market will fall. They could then bet on the market rebounding or, at the very least, not falling by more than 10% from current levels.
Other traders are betting that the market will continue to rise. They could place similar wagers that the price of a particular stock, bond, index, or cryptocurrency will fall. Both sides of the trade – whether they’re betting that the market will rise or fall – are essentially combining short-term market movements with fundamental analysis that attempts to determine the “longer-term” direction of the market.
Short-Term Market Dips Are Common
Even investors who aren’t looking to make short-term market fluctuations usually find themselves on the wrong side of the market at some point or another. As a result, they might find themselves entering into a short-term bear market when they had hoped to be in a long-term bull market. This doesn’t have to be the case, though. Just because the market is currently in a state of decline doesn’t mean that you have to follow suit. Market dips below important support levels – such as the 50-day moving average – which indicate that short-term bears are more likely to emerge.
Watch Out For Signs of a Short-Term Bear Market
You wouldn’t want to be on the wrong side of the market when it decides to turn around and appreciate in value. The same concept applies when a short-term bear market is unfolding. In both scenarios, it’s important to watch for warning signs that might indicate that the state of the market is about to change for the worse. One key difference between a long-term market rise and a short-term market decline is that the latter tends to be more volatile. Short-term market moves can be quite dramatic, and it’s not uncommon for the market to drop by 20% or more in the span of a few weeks. During these steep declines, even experienced traders might find themselves in a position where they have to quickly exit the market due to significant losses.
The Volatility Level Is High
One of the best indicators that a short-term bear market is emerging is the high level of volatility that characterizes the market. Volatility is the amount of fluctuation that a market or an investment property exhibits. In the above chart, note the high volatility levels in gold and the precious metals sector in general. High levels of volatility often indicate that short-term Bears are more likely to emerge. When the market experiences high volatility levels, it can be difficult to accurately predict its direction. Short-term market declines are often followed by long-term rallies, and vice versa. As a result, even the most astute market observers might be reluctant to predict the direction of the market with any degree of accuracy.
The Major Market Indicators Point To A Bear Market
Now is a good time to review important market indicators so that you can better understand the current state of the market. The following chart shows the current position of several crucial market indicators:
- The 10-year Treasury bond yield (TYU10Y) is currently at its lowest level since October 2017, which is a positive sign for long-term Treasury bond owners. Note that when 10-year yields are at their lowest, it often means that long-term interest rates are also at their lowest. In the event of a long-term bond purchase, low long-term interest rates and the potential for capital appreciation might make it worth the investment. The reverse is typically true when long-term bond yields are at their highest.
- The yield on the 10-year Note (TYU10) is also at its lowest level since October 2017. As a result, both long-term interest rates and Treasury bills have fallen to earth. With rates and bills at their lowest, there’s little reason to anticipate big rises in either. Short-term interest rate exposure might be appropriate for those who want to make a quick buck from the emerging market decline. Short-term interest rate exposure combined with long-term capital appreciation might also be a good strategy for those who want to “wait it out” and let the market rise again before taking their profits.
- The VIX® (VIX) volatility index is also exhibiting relatively high levels of volatility at 39.85 as of this writing. A high level of volatility in general, and the VIX in particular, often presages lower stock market and broader market values in the near future. The VIX is currently trading near one of its highest levels since March 2009, which is another positive sign that a short-term bear market is emerging.
- The CRB® commodity index – commonly referred to as the “Basket of the Decade” due to its heavy weight in crude oil, copper, platinum, and gold – is also exhibiting elevated levels of volatility. The price of crude oil (BBLCL) recently declined by 7.8% to its lowest level since late 2018, which might partially explain the recent increase in the VIX. Low oil prices tend to boost the demand for safe haven investments, such as gold and the Swiss franc. Although crude oil prices have recently turned around and begun to rise, uncertainty surrounding the future of oil supply makes it difficult to accurately predict the direction of the commodity.
- The broad market (CRB) as measured by the S&P 500 and the Dow Jones Industrial Average is also near its lowest since early 2018 as of this writing. Together, these three market indices have declined by 13% since early 2018. The sharp fall in the last quarter of 2018 was also partly the result of increased short-term interest rate volatility, which caused yields to spike up and prices to decline. The recent decline in the broad market is likely a result of interest rate volatility and decreased stock market confidence. Short-term interest rate exposure combined with long-term capital appreciation might be a good investment strategy in this scenario.
- The Russell 2000 (IWM) is one of the many small-cap and mid-cap stock market indices that tend to outperform large-cap indices during market downturns. IWM is currently in a state of decline as of this writing, and it has declined by 17% since its September 2018 peak. Like the other market indicators discussed above, a reduction in the IWM is often followed by an increase in the overall market and in long-term government bond yields. The IWM recently declined by 11% to its lowest level since early 2019 as oil prices continue to decline. Long-term interest rate exposure combined with short-term stock market exposure might be a good strategy for those who want to participate in the emerging market decline.
The Impact Of Tax Reform
The recent tax reform bill dramatically changed the way that individuals and small businesses will file their taxes in the future. The main difference is that individuals will now have to pay taxes on their entire income, rather than on the amount by which their adjusted gross income exceeds a certain threshold. This means that more individuals will become “tax-filers” and less will be “tax-exempt”. How will this change your investment strategy? If you’re looking to participate in the gold and precious metals market, you need to consider the new tax structure and whether or not it will affect the investment decisions that you make. To begin with, small- and medium-sized precious metal companies might see their profitability decline significantly as a result of the new tax structure. Along these lines, the XAU, which tracks the price of gold, has recently declined by 6.5% as of this writing. The reason is that numerous small and mid-sized precious metal companies will be forced to close shop due to the increased burden of taxation.
How To Guard Against The Upcoming Market Decline
Although it’s important to watch for warning signs that the market is about to decline, it’s also important to consider how you might profit from the upcoming market decline. If you’re looking to short-sell the market, you’ll need to consider whether or not you have the resources to do so. Remember, short-sellers need to place huge bets that the price of a particular security, stock, or commodity will decline. If you’re not prepared to risk huge sums of money on one bet, it’s not smart to enter the market with the intention of short-selling.