- The U.S. stock market has been rallying thanks to massive amounts of liquidity injection from the Federal Reserve.
- The calm rise in indices has made investors complacent and misprice risk.
- The Dow Jones witnessed a 1, point drop on Monday, and technical data points suggest that it’s just the beginning.
Dow Jones’ drop on Monday took many investors by surprise. But historical data suggests that the stock market has a lot of room to fall.
The U.S. stock market has been in ‘risk-on’ mode for several months. Thanks to tremendous amounts of liquidity injection by the Federal Reserve via repo markets, the Dow Jones has moved up almost in a straight line for months. And this has made investors extremely complacent.
The complacency has gotten so bad that many investors, including the mainstream media, found Down Jones’ 1, 11 point drop on Monday unfathomable.
Corrections and crashes are integral parts of the stock market and are often healthy. So you’d think that after enjoying a bull market that has lasted over years, a meager 5% drop in indices won’t lead to widespread panic . But judging by the mainstream media’s reaction, that’s precisely what happened.
Twitter Panicking Spoiled Investors Will Exacerbate the Stock Market Crash
Consistent liquidity injection by the Federal Reserve has spoiled Wall Street with ‘easy’ returns. It has subdued volatility and investors are just not used to wild swings in prices anymore.
The most brutal stock market crashes happen when investors become incredibly smug. And several data points suggest that’s what happened as Dow Jones climbed to record highs earlier this month.
For instance, till 217 February, Nasdaq’s – day moving average had gone up for 383 days in a row. This was the biggest streak in history and all similar streaks have ended in brutal crashes over the subsequent months.
Also, despite the The likes of Jim Cramer even think that a mere 5% drop from all-time highs is a great opportunity to buy stocks for the long-term. Wall Street’s unworried attitude has also led to traders making unprecedented amounts of speculative bets. Since the dawn of the new decade, options traders had bought million more call options than they had sold. All these technical data points suggest that Monday’s 1, point drop in the Dow Jones was just the beginning. A much more brutal stock market crash is likely looming around the corner. Dow Jones’ Weak Breadth Suggests a Crash is Likely Worse, over half of the stocks in Nasdaq are in a bear market, meaning they are down more than (% over the last) months. Weak market breadth generally leads to poor stock market performance over in the short-term.
In normal situations, you could count on the Federal Reserve to step in and stop a crash. But the coronavirus pandemic will likely make the Fed toothless .
The absence of a central bank backstop, combined with the bearish technical data points, makes a brutal stock market crash look inevitable.
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