Parabolic Markets Never Correct by Going Sideways

The parabolic move upward in the S&P500 continued last week. The index gained another 0.86% on moderate to weak volume. Interestingly, because this contradicted the move higher in the S&P, the VIX index also closed higher on the week.

In US macro news, the Empire State manufacturing survey missed consensus expectations. The housing market index also missed. Housing starts disappointed…badly. The Philly Fed business outlook survey also disappointed. And consumer sentiment came in well below expectations. For the week, only industrial production and initial jobless claims showed better than expected results. So on balance, last week’s results were skewed to the downside.

In terms of technical analysis, the S&P continues to trace out a classic parabolic “blow-off top” formation. Prices are not only deviating from long-term moving averages, but the percent of the deviation is increasing. This means that the slope of the increase is becoming more steep. The problem with such a pattern is that historically, it never corrects by going sideways for a while. In other words, prices don’t just pause in a safe range near all-time highs waiting for fundamentals to simply catch up to them. In every case when major equity markets, or even sectors, have gone parabolic, the correction that inevitably followed was roughly and equally steep drop, a drop that completed the second half of the parabola.

So as the fear of missing out grows, and more and more mom-and-pop investors rush in to buy stocks at all-time highs, most everyone joining this party is either unaware of how markets correct or simply refusing to believe that such a correction will happen to them after they get in.

Meanwhile, the list of new records, records that put into perspective the magnitude of this sky-rocketing stock market, continues to grow. In only a short while, the S&P will be setting the new all-time record for the most number of consecutive¬† trading days without suffering a 5% correction. Remember, this type of record goes back not just a decade or two, but about a hundred years. Apparently, many investors refuse to believe that any such correction could ever happen again, or if it does, somehow—unlike almost everyone else already in the stock markets—they, and only they, will have the wisdom to know it’s coming and will be able to jump out before stock markets actually correct.

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