The SPY, a popular barometer for the performance of equities in the United States, had been on a nice run since its October lows.
The key word being “had.”
In October and November, the SPY rallied from approximately 288 to just north of 315, an appreciation of about 10%. Until the start of this week, it appeared that the traditional “Santa Claus rally” had arrived early in 2019.
The term “Santa Claus rally” refers to the historical tendency of U.S. equities rising between Christmas and New Year’s Day—a time when optimism tends to abound. In recent years, data indicates that Santa Claus rallies have been starting earlier, or at least that equities have tended to rally from Thanksgiving to New Year’s with a relative degree of consistency.
One glaring exception was last year, when equity prices started tanking in October and continued to correct all the way through the start of the new year. In 2018, the SPY actually closed as low as 240 before ultimately rebounding and climbing above 280 in late February of 2019.
And after a couple days of sharp selloffs in U.S. equity markets to start the week of December 2nd, many market participants are probably left wondering if “Part Deux” of last year’s winter meltdown might be on the horizon.
Last month, there were a myriad of headlines suggesting that trade negotiators from the United States and China would soon be popping champagne after signing a so-called “Phase 1” deal. But plans for signing post-party took a big hit Tuesday when President Donald Trump warned a deal might not actually be signed until after the presidential election in November 2020.
An equity market that was weak on Monday got even weaker on Tuesday, and in just two days, the SPY had quickly given back 2% of the October and November gains. The immediate question is whether the president’s comments were intended to serve as further negotiating pressure, or as an actual signal to the financial markets that investors should start adjusting their expectations accordingly.
If it’s the latter case, it’s hard to imagine a scenario in which global equity markets don’t correct further—or, at the very least, exhibit a higher degree of volatility. As a reminder, a correction doesn’t become technically “official” until it passes a decline of at least 10%.
And while nobody can accurately predict whether this is a quick downdraft to be followed by a usual Santa Claus rally or the start of a deeper pullback, the best thing any trader or investor can do at this time is make sure they are prepared to navigate troubled waters.
This is vital not only for risk management purposes, but also for ongoing strategic positioning.
As of last week, the SPY was notching new all-time highs, and the best known market gauge for volatility, the VIX, was trading fairly close to all-time lows. The SPY and VIX share a strong inverse historical correlation, which means those respective levels weren’t exactly a surprise.
The VIX has already popped several points (15+) in response to the last couple days of heightened volatility. But looking ahead, if trade war negotiations go further off the rails, or if another macro event sours sentiment further, is there data or information traders can lean on to help them navigate going forward?
The answer is resoundingly “yes,” especially for those that follow the tastytrade financial network.
In three previous episodes featured on tastytrade, research is presented which should help traders optimize their decision-making during periods of market instability. Likewise, historical data framed on these shows can additionally help traders better recognize when new patterns are emerging in the markets, as well as some choices for capitalizing on them.
In a recent episode of Futures Measures, for instance, the hosts of this show examine historical data in stocks, bonds, gold, crude oil and currencies to help illustrate how these assets perform when they hit price extremes.
As a complement to that, a previous episode of Options Jive delves into historical data in SPY to demonstrate how this index ETF has tended to behave after a correction. The information presented on this show should be particularly helpful to traders looking to build their confidence when trading market pullbacks.
Likewise, a past installment of Market Measures also represents compelling viewing due to a market study presented on the show that highlights historical data in the VIX. This research was conducted exclusively by tastytrade, and reveals that a VIX reading above 20 has historically served as a strong, positive signal for the deployment of high-probability short premium positions.
Traders watching all three shows will undoubtedly better equip themselves for the next big market correction, whenever it does finally materialize.
Sage Anderson is a pseudonym. The contributor has an extensive background in trading equity derivatives and managing volatility-based portfolios as a former prop trading firm employee. The contributor is not an employee of Luckbox, tastytrade or any affiliated companies. Readers can direct questions about topics covered in this blog post, or any other trading-related subject, to firstname.lastname@example.org.