Stocks rebounded this week, reversing late September’s sharp slide and hitting a seven-week high. So is the correction over? We will know only in hindsight—short-term, sentiment-driven volatility is inherently unpredictable. However, negative market volatility tests even the most disciplined investors, and some—or any—evidence the bounce is nigh would probably feel nice. So it may be tempting to buy into chart watchers’ predictions that some lines and index levels indicate the bull is ready to resume its rise. But all the citing of technical indicators strikes us as an attempt to time the bottom of the current correction—a counterproductive and potentially harmful exercise for long-term investors.
After the S&P 500’s recent string of up days, some technical analysts have closely monitored its price level to decipher what the index will do next. According to Technical Analysis 101, the S&P allegedly encountered some “resistance” earlier this week. Said another way, stocks hit a “ceiling” preventing them from rising higher. One analyst noted Tuesday that the S&P was stuck in a range between 1959 and 1991.[i] So, the technical logic went, if stocks broke through that 1991 “ceiling,” they would keep rising until bumping into the next ceiling (2011 for this particular analyst). But if they crashed through the “floor” of 1959, they would enter a new lower range—and have to fight through a new ceiling (and likely more resistance). Some experts were extra bullish because volatility—as measured by the Chicago Board Options Exchange’s Market Volatility Index, or the VIX—is falling.
So what happened? Welp, the S&P broke through ceiling one on Wednesday and ceiling two on Thursday, then drifted still higher on Friday—just to remind everyone technical mumbo-jumbo is a bunch of gobbledygook. Index levels are neither a floor nor a ceiling. They are arbitrary numbers our brains latch onto out of a desire to create order in markets, which are random and haphazard by nature. Past performance doesn’t predict future returns, and natural physical forces like momentum and gravity don’t apply to capital markets. Taken at its most literal, technical analysis would say that after Thursday’s close, stocks should rise perpetually. Friday might seem to lend credence to that, but trust us, smashing through an index level doesn’t ensure further gains. If it did, then we wonder how stocks would go down to create that resistance in the first place.
The VIX is a pretty flawed market gauge, too. It uses options prices—which are partly determined by volatility—to forecast the S&P 500’s volatility in the following 30 days. However, volatility isn’t predictive of anything. Plus, the VIX attempts to estimate the magnitude of volatility, but not the direction—positive or negative—to expect. People just read too much into it. Heck, the VIX isn’t even terribly good at forecasting future return magnitude. It’s about as useful to you as a dartboard.[ii]
Look, we’d love to be able to know whether the correction is over or another downswing lurks. But it’s impossible. Corrections are sentiment-driven, and investor sentiment can be pretty darn fickle, especially in the short term. It is near-impossible to forecast how investors will behave and react day-to-day, and we don’t recommend trying to do so, as it would probably drive you nuts[iii].
Moreover, bottom-hunting is unnecessary and counterproductive for long-term investors. Focusing specifically on one near-term point shifts investors’ focus from long-term growth to short-term market timing—a dangerous mindset. Many folks struggle to stay disciplined when negative volatility strikes. According to prospect theory—also known as myopic loss aversion—losses feel about two and a half times more powerful than gains. Naturally, most folks want to alleviate that pain, and doing something—like calling a bottom—might seem an easy solution, giving you instant peace of mind. But if stocks fall anew, might find yourself even more rattled. Portfolio declines become real losses only if you sell—if you remain invested, it’s just a blip in your rearview mirror.[iv] And the average annualized return during bull markets—including corrections—is 21%.[v] If you require growth for your portfolio, staying fully invested is vital to benefit from those long-term returns. Keeping a long-term perspective is step one to staying disciplined.
While it has been several years since the last correction, these market declines are normal features of bull markets. This is the current bull market’s sixth correction in global stocks—and none of the prior corrections stopped the bull from resuming. Though the negative volatility is uncomfortable, the short-term discomfort is the price to pay to benefit from stocks’ long-term returns. Attempting to navigate corrections shifts attention from the long term and potentially induce investors to make short-sighted decisions. Rather than trying to divine when the correction will be over, we suggest looking at reasons to be bullish—and that list is long.
[i] Interestingly, a day after The Wall Street Journal published this analyst’s view, the S&P 500 closed on Wednesday at 1995.83. So, ceiling broken, it appears.
[ii] Or less, it’s fun to play darts.
[iii] Or maybe not, again, hard to predict sentiment and how people react to things!
[v] Source: FactSet, as of 3/18/2015. S&P 500 Price Index bull markets since 1932.