Summer is the riskiest time for overbought stock markets
There’s increasing chatter on social media about a stock market bubble, credit bubble, housing market bubbles and worries over the Chinese economy (and its own credit bubble issues). So I thought I would review the history of stock market corrections.
Going back to when my career started in financial markets in 1987, a clear pattern emerges.
Global stock markets suffered a famous crash in October 1987. Dubbed ‘Black Monday’, markets shed a huge value in a very short time. The crash began in Hong Kong and spread to Europe and the US after other markets had already declined significantly. This was after the market had actually hit its peak in August 1987.
The next significant decline was only three years later. The drop was less severe but the S&P still corrected 10% from July/August 1990 to a low two months later. This index then corrected 10% in February 1994 with another fall of just over 10% in July 1996.
So, three significant corrections in the nine years following the 1987 stock market crash.
The next most significant correction after 1987 occurred from July 1998. The S&P collapsed from 1190 to 923, a drop of 22% in just three months. A year later the S&P corrected by 13% in July 1999. This was a year before the bursting of the big internet bubble which started in September 2000.
Are you noticing a pattern here? Five of the seven corrections started in July/August and the biggest crash started only one month later in September 2000. The only other significant correction in that 13-year period was in February but this was one of the smallest.
If you were interested in protecting your investments, or looking for the best time to short an overbought stock market, July/ August was the clear winner up to 2000.
So what has been the trend for this century so far?
The first significant correction after the S&P started a recovery in October 2002 occurred in July 2007. The index fell almost 12% from 1556 to 1370. This was just before the peak of the market at 1576 which was hit in October 2007.
This may not have been the starting point of the Global Financial Crisis, but it was the start of a 16-month 57% crash from 1576 to 667.
The next two significant declines were in April 2010 and May 2011. So these two do not fit in with our summer sell-off pattern. The market then began a very steady growth trend up until the peak in September 2014 just before the flash crash – only a month late!
The last significant correction we experienced started in July 2015. Prices fell 12.5% from a peak of 2134 to bottom in August at 1867. A small correction in August 2016 saw only a 5% drop.
So we have four corrections from 2007 to date in July-to-September with two in April and May.
In my 30-year career, that is nine of the twelve corrections occurring from July to September. Seven of the twelve corrections occurred in July and August alone.
You may be concerned the stock markets have gone a little too far over the past eight years, having risen 267%. If you’re looking to cash in or perhaps even take a gamble on buying some S&P 500 puts this year, selling your holdings or shorting the market in the July-to-October period may be the safest bet.
At the very least, buying protection on your stock portfolio is at very cheap levels. The VIX is the ticker symbol for the CBOE Volatility Index, which shows the market’s expectation of 30-day volatility. That’s why it’s also known as the ‘fear index’.
When the VIX is low it indicates the market believes volatility will remain low. Therefore, the market is not buying protection as we continuously hit new all-time highs. A shock could then have highly negative consequences in a market where the participants are feeling complacent and large short positions exist.
The crash of 2007 saw the VIX rocket from 9.39, close to its all-time low of 9.31 (December 1993) to a high of 89.53. And guess what? The VIX just hit a new multi-decade low in June at 9.37, a level not seen since the all-time low in December 1993.
The VIX was not tradable in 1993. But this time around there is a record or certainly near-record number of shorts in the VIX. The chart below shows the VIX going back to 1990.
Technical Analyst & Trader
For more information, trading education and offers visit Intertrader
The content of this article is the personal opinion of the author and not Intertrader. You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.