Time For A Face-Ripping

The Market Faces A More Violent Reversal Now

I’m starting to see some fear creeping into the markets. There’s plenty of places where you can see it. Sentiment readings are falling. The VIX is climbing. Treasury yields are heading lower.

The thing is I’m not sure how investors know how to handle fear right now (or ever really). If you listen to some folks, they think the sky is falling and it’s only going to get worse.

Take, for instance, this chart showing how far the major U.S. equity indices are off of their highs.

As I write this, the S&P 500 is down just over 6% from its high. The Nasdaq is right on the cusp of being in correction territory at -10%. To listen to some people talk about it, we’re in the middle of a face-ripping bear market. As far as the S&P 500 is concerned, this is just a garden variety pullback. If you look at history, 5% pullbacks in the S&P 500 usually occur around 3-4 times a year. Even 10% corrections typically occur every year and a half or so. This isn’t unusual.

The last time investors had to deal with this was the reverse yen carry trade unwind in August & September of last year. Even the damage there, while swift and sharp at the time, was largely undone within a couple months. To find the last real correction in U.S. equities, you’d have to go back to the inflation bear market of 2022.

But that fear might be warranted this time around.

I brought up the reverse carry trade just now because I don’t think it’s over. I think that plus a couple of other factors could turn the current 6% pullback in the S&P 500 to something like 20% or even more. And it might not be a gentle bear market like the one in 2022 where the VIX almost never got out of the 20s. I’m talking about an environment where volatility gets much higher and results in the kinds of whipsaws that send amateurs running for the exits.

Let’s go ahead and make the case for this right now.