Assessing Market Extremes

Whether the market goes up or down, there are many variables we survey to determine whether we believe the market is materially overbought or oversold. In this latest edition of LPL Street View, LPL Financial Director of Research Marc Zabicki takes a look at one of those variables as we attempt to assess whether this latest drawdown is in the early, mid, or late innings.

The most recent market sell-off has perhaps been made more uncomfortable than others due to the fact that it’s a sharp contrast from the relatively smooth market ride we have witnessed since late March of 2020.  We believe much of the downturn comes from the concern over inflation and the ability of the Federal Reserve to offset inflation without pushing the economy into recession.

We believe that inflation may have already begun to subside.  The April headline CPI number was slightly below March’s 8.5%, which is good news.  We also think a downtrend inflation readings could continue, and sould this trend develop, we believe that will alleviate some market distress.

Regarding current distress levels, there are several things we watch that may help identify extremes in the market.  One factor we look at is a chart that shows the ratio of the S&P 500 Index’s one-year return relative to the CBOE Volatility Index. The latest chart points to current downside extremes that rival the beginning of the COVID-19-era and Q4 of 2018 and Q1 of 2016, which are three periods of decided market volatility. 

Based on this chart and other technical and sentiment indicators we follow, we believe we may nearing the late innings of this period of market distress.  Our fundamental market and economic work shows that this current bout of market fear may be overdone.  We are now waiting for more formidable technical or sentiment signals that would indicate a time to adjust our suggested asset exposures to position for an equity and bond market rebound.  That time has not yet come, but we are anticipating its potential near-term arrival.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth in the podcast may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. All indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

All index data is from FactSet.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The CBOE Volatility Index (VIX) is a measure of the volatility implied in the prices of options contracts for the S&P 500.  It is a market-based estimate of future volatility.  When sentiment reaches one extreme or the other, the market typically reverses course. While this is not necessarily predictive it does measure the current degree of fear present in the stock market.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This Research material was prepared by LPL Financial, LLC. 

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