Dow Coils Before Christmas

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Wednesday’s trading range for the Dow Jones Industrial Average was just 55 points. To put this in perspective this is the narrowest it has been since the 2nd of July 2014 (a whopping 624 sessions). Moreover, this follows Tuesday’s trading range of 67 points.

Coinciding with this, Wednesday also saw the CBOE Volatility Index (VIX) fall below 11, its lowest since August 5th 2015. The VIX is a measure of market expectations of near-term volatility as priced by S&P 500 stock index options and is known as the ‘fear gauge’.

The index dropping below 11 indicates that investors have all but eliminated the prospect of near term market turmoil.

However, bear in mind that the last time the VIX fell below 11 was in August 2015 and things didn’t end well then. A mere two weeks later the index rocketed to 53 and equities fell sharply as fears of a Chinese financial crisis took centre stage.

That said, with current market sentiment firmly bullish, confidence in the US economy improving and earnings showing signs of a decent recovery expectations of a 2016 ‘Santa rally’ remains high. We all know December has historically been good for stocks and so far this pattern looks intact.

Furthermore, let’s not forget that periods of price compression are, after all, a crucial characteristic of any trend worth its salt.

Be that the case, the magnitude of the post-US election rally does beg the question as to whether investors are too optimistic regarding Trump’s ability to fuel economic growth. With the Dow Jones rallying 8.7% since the US election some believe Santa Claus has been and gone.

Whether that is true or not is of course the million-dollar question, but either way one thing is clear. Continued periods of range contraction are historically followed by periods of range expansion.

We should note that the spread between realised and expected volatility is at year highs, something that the bears are clinging on to. However, given the strength of the recent underlying uptrend the probabilities suggest that the odds of a Santa rally are favourable.

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