This essay was originally published in DailyWealth Trader, a daily trading advisory, and has been adapted. To learn more about this service, click here.
Investor fear spiked in October...
The S&P 500 Index was in correction territory. And investors were on edge as the broad market fell hard for the first time in 2023.
Today, the index is bouncing back. The fear we saw in October is starting to fade. And the market's "fear gauge" shows a new run higher is likely starting.
Specifically, it suggests a double-digit rally is underway. And it's a good reason to bet on continued gains in the market.
Let me explain...
One of the simplest ways to measure fear is the CBOE Volatility Index, better known as the VIX.
When the market starts to crash, the VIX runs higher. A reading of about 20 means fear is elevated... And if it's above 30, fear is extreme. Anything above 40 marks a historic event.
The chart below shows the VIX in action. Each time the S&P 500 pulls back in a big way, the VIX jumps...
The quicker and sharper the downturn, the higher the VIX is likely to go.
A spike in the VIX tells us investors are panicking. But we can take it one step further to know when stocks are likely to rally afterward.
You see, once fear starts to go away, that can indicate more gains are on the way. And we can look to two decades of data to prove it.
Let's use the most recent case as our guide. The VIX rose above 20 in October and is pulling back. It's now slightly below 15.
We tested two factors to see if this is bullish for the market. First, the VIX had to be above 20 in the past month. And second, it had to fall below 15 for the first time in a month.
Since 2000, buying after these kinds of signals has been a good idea. Check it out...
The S&P 500 hasn't done great since 2000... It has returned just 4.8% a year. But buying after the VIX drops from above 20 and to below 15 results in a much better return...
These cases typically lead to a 4.1% gain in six months and a 9.9% return over the next year.
Those might not be home-run returns. But that's a very bullish case for the broad market.
Importantly, this indicator also has a high win rate over the 23 years we studied. We've seen 22 other cases like this since 2000. Buying after those periods led to a six-month gain 77% of the time. And when you look at the one-year return, that win rate jumps to 86%.
That's about as reliable as an indicator gets. And it bodes well for the S&P 500 over the next year.
Stocks have continued rallying since this indicator flashed in recent weeks. But history shows that more gains are likely in the coming year.
That means you have time to get in as the next leg higher takes off. So don't miss out as U.S. stocks climb higher.
Good investing,
Chris Igou
Further Reading
The market took a beating in October. But since then, stocks have rallied higher. While corrections like these may worry investors, they're also incredibly common. And history shows the short-term pain could even be setting the stage for future gains... Learn more here.
"The overall stock market has been a wealth-compounding machine for the past seven decades," Brett Eversole writes. If you buy at the right times, though, you can set yourself up to do better. And after the recent fall, we're likely seeing one of those opportunities now... Read more here.
