No. Let's take a look at the monthly chart just for some perspective here. On this chart that correction is barely recognizable. Looks like the uptrend is completely intact. The 2011 correction was really the last "noticeable" correction. My 2nd argument is the VIX. Last year's correction only saw a spike up to 30 which in a 12 vix world seems like a lot but the reality is, the long term avg VIX is really in the 20's!!!! In 2011 we saw the VIX get up to 50. My next post will follow up on economic theory...
Economic Theory! Ok, so I've talked at length on here about Prospect Theory and it's really fascinating because it very accurately describes human behavior and why we take risks. Just to review, I'll go over it again. The theory states: A randomly chosen person is offered two outcomes: 1) Guaranteed $10, no questions asked, just take the money. or... 2) Flip a coin. Heads you get $20, tails you get nothing. The average person who is risk averse, which is most of the population, will take option 1. They will seek security. The $10 leaves them better off then they were before at no additional risk. Please note that the expected values are exactly the same. Under both choices E (X) = $10. But option 2 has more variance. There is a risk. So given the same expected value, you should seek the return that offers the lowest risk. Now scenario two: A randomly chosen person is "forced" to pay for the flip. Heads they win $20, tails they lose $20. If they "win", we go back to scenario 1. Offer the chance to walk away or play again. They walk away as they should, it's the same formula as above. Now, to those who lost, we offer them the same bet that they would have "rejected" earlier. We say to them, they can flip again. Heads they win $20, tails they lose $20. If they win, they recover their losses and they are happy. If they lose, they are now deeper in the hole. Should they take this bet? It's exactly the same bet as before only now it's conditional in the fact they are in deficit. What we have found is that under this scenario, people suddenly are no longer risk averse but become "risk seeking" individuals. They are acting irrationally. The expected value of this outcome is ZERO! They have nothing to gain. In fact, not only is the outcome zero but it comes with variance!!!!! They are actually willing to take risk with no positive expected return. They "modified" their behavior simply because of the outcome of the first flip. Now let's apply this theory to markets. Risk assets have been going up for 6 years with relatively little to no volatility. This is our coin flip. In fact you could make your units of time daily, weekly, monthly or annual. Each unit of time is a coin flip. The investor is winning. But they becoming more risk averse. Why? I'm going to leave some of the math out of this for now but it relates to their elasticity of demand. Elasticity's change when quantity of wealth changes. In other words, as you accumulate more wealth, you have "more" to lose. Hence the old saying "when you've got nothing, you've got nothing to lose". Poor people can afford to be risk seeking. In fact they SHOULD be. Asymmetry is working in their favor. Rich people should not be risk seeking (law of diminishing returns). So this explains why as the market rises, it does so on lower and lower volume and lower and lower volatility. People become more risk averse and more protective of their capital. Now, we get a shock. A sharp drop in prices. The coins have gone Mad!!! Behavior changes. Suddenly people have lost a lot of money. People react very differently when things are taken from them. Now, they want their money back. They become risk seeking! What happens. They trade more, more size, more leverage. Suddenly long term value investors become momentum investors. Suddenly people who never averaged down are doing so again and again. They will fight and fight and the more they try to recover their losses, the more losses they realize. And the cycle repeats itself on the final leg up. The move is sharp, violent and relentless. They provide the last drop of liquidity to smart sellers who sell into them. And when the smart sellers are done, the investor suddenly notices there are not enough life boats on the Titanic. Panic ensues. Prospect theory explains market cycles very well. Some of you might even recognize your own behavior in here. Don't worry, that makes you normal. But understanding this theory is important to understanding market behavior.
Thanks Maverick it makes sense. Thinking fast and slow is really really phenomenal book exactly on this topic. If someone haven't read it yet - I highly recommend.
Thanks for the insight Mav....food for thought. Add in a million refugees looking for homes etc. and U.K. polls now favouring a Brexit, Mario Draghi will be 1 busy boy.
HO much stronger than RB at this time, especially as we go back a bit in the curve. Jan HO almost confirming to the upside on the 30 day while the front has barely reset.
My small cap index (IJR) also confirmed today. High yield bonds (HYG) will confirm tomorrow with a zero or higher and so will Silver (SLV)! and it hasn’t been in that position for some time.