Editor’s Note: Regular readers know Bill’s warning: a bear market is overdue. Professional stock trader Jeff Clark agrees. But Jeff is actually looking forward to the bear market. He believes triple digit gains will be made in days – not years – during the volatile times ahead. Editor at large Chris Lowe sat down to get the full story.
Chris Lowe: Jeff, we saw a huge spike in the CBOE Volatility Index (VIX) – the market’s “fear gauge” – at the start of this year. But it’s since dropped again. What makes you so sure volatility is here to stay?
Jeff Clark: Here’s the thing I’ve noticed about the VIX during my 35 years as a trader: Periods of low volatility are always followed by periods of high volatility. And vice versa. It’s a highly cyclical thing.
My experience of studying and trading volatility cycles is that they tend to be time-symmetrical. In other words, the low volatility periods and the high volatility periods tend to last just as long.
So since we went through about 14 months of low volatility, we’re probably now looking at about 14 months of high volatility – taking us through to the middle of 2019.
Chris: What does that mean for stocks?
Jeff: It means we are headed into a bear market. The VIX acts like a canary in a coal mine. It tends to spike about three to six months before you get the final peak in the stock market. Take 2007 as an example. The VIX first spiked in March. The S&P 500 peaked in October.
I don’t think it will take that long this time. I think we’re probably looking at maybe four or five months.
Chris: How bad do you think the bear market could get?
Jeff: I think stocks could drop 40% to 50%. Most bear markets tend to reverse about 50% of the gains seen in the preceding bull market. The S&P 500 hit a low of 666 on March 6, 2009. Now, we’re 2,000 points above that. So a 1,000-point drop would be about a 40% fall from where we are right now.
And since the market always likes to overshoot, I think we might get closer to a 50% drop.
Chris: Back in 2008, the Fed came to Wall Street’s rescue. Do you see that as a possibility in the next bear market?
Jeff: Well, back then, what they did was they dropped short-term interest rates to zero, which meant you could borrow money for free. Then they started “quantitative easing” or QE. It was a massive money-printing operation. The Fed created about $4 trillion in cash that didn’t exist before and injected it into the system. Much of that newly created cash ended up in the stock market.
We don’t have that opportunity right now. Interest rates are still under 2%, so there isn’t much room to cut. And the Fed is in the process of reversing QE.
Look, there’s any number of things that our glorious leaders in Washington can propose. Most of them border on stupidity. I thought the idea of a zero interest rate was stupid, but they got away with it for a very long time.
People have been talking about negative interest rates. That’s even crazier.
[Negative interest rates are a tax on savings. Instead of the bank paying you interest on your deposits, you pay your bank for the privilege of having it hold onto your savings.]
Can you imagine the baby boomer population, which is now facing retirement, earning nothing on their savings? Or worse, paying banks to hold onto their savings?
Chris: So you see a bear market coming. Why are you so excited?
Jeff: Well, I’m a trader. And although most folks hate seeing big swings in the stock market, traders actually thrive on volatility.
It may sound strange to your readers, but I like to see things move up and down, up and down, up and down. I also like to hop in and out of positions. And if you don’t have market action that facilitates trading, you sit on your hands and don’t do much of anything.
Last year was a tough year for most traders because there was such low volatility. But the kind of volatility we saw in the first quarter of this year – which I believe is going to be a feature of the market for much of 2018 – creates a lot of extreme conditions for traders to profit from.
Chris: Can you expand on that point a bit? What do you mean by “profit from extreme conditions”?
Jeff: I’m a reversion-to-the-mean trader. Imagine you have a rubber band, and you stretch it out. Then you let it go, and it snaps back quickly. The same thing happens in stocks. They get extremely overbought or oversold. The rubber band stretches. Then it snaps back.
I look for extreme conditions that provide opportunities to trade. They tend to be high-probability, low-risk trades. I wait for the rubber band to be stretched. Then I profit when it snaps back.
Now that doesn’t mean all my trades are automatic winners. I wish! But I’ve been doing this for 35 years. That rubber band sometimes stretched further than I thought it would, but it almost always snapped back.
Chris: You used this strategy back in 2008 to make gains of 133%, 166%, 182%… even 225%. Can you explain a bit more about why 2008 – one of the worst years for investors in living memory – was so good to you?
Jeff: You’re right, 2008 was a horrible, horrible bear market for stocks. But it was one of the best years ever in my career. And, maybe surprisingly, about 70% of my trades were on the long side – meaning I was betting on higher, not lower, stock prices… albeit over short time frames.
You see, with investors in full-blown panic mode, we got these brutal correction phases. Stocks got so extremely oversold that the most likely next move – at least in my eyes, as a reversion-to-the-mean trader – was a rally.
And sure enough, after the big sell-offs, we saw these one- or two-day wonder rallies. They would come out of nowhere.
Traders who had swooped in and bought stocks after they had become oversold – when the rubber band was stretched, in other words – made almost instant profits when it snapped back.
Chris: So if you can act like a trader, you can profit from short-term market conditions like the return of volatility?
Jeff: Oh, yes. And I’m looking forward to this next one. My readers did very well in 2017. Of the 80 trades I recommended, more than half were double-digit winners.
But because of the low levels of volatility last year, it took three weeks, four weeks, or even five weeks for trades to play out. It sounds sort of ridiculous. “Oh, my God, I had to wait four weeks to make money in the market.” Right?
But in a really volatile market, these sorts of trades typically play out in two or three days. So I’m looking forward to that happening. We’ll be able to shorten the time span with many of our trades. And we’ll have many more trades to go with.
Chris: What about folks who aren’t interested in trading? Do you have any specific advice for them as your bear market forecast plays out?
Jeff: The first thing they should do is try to remember how their portfolios fared in 2008. Were they comfortable just riding out the panic? If so, okay…
But if 2008 was horribly uncomfortable for your readers and they had nightmares about the losses in their portfolios, then they need to do something today. Either lighten up on stocks and raise some cash, or make sure they have stop losses in place.
[A stop loss is an advance order to sell an asset when it reaches a particular price point. It is used to limit the loss or gain on a trade.]
This is all about protecting your capital. Because I really do expect a drop of 40% to 50% in stocks. And it could happen as soon as this year. Now, maybe I’m wrong. Maybe it won’t happen. But you need to have a plan in place.
And of course, gold is always a good thing to have. Maybe have 5% or 10% of your portfolio in gold. It’s not going to get ravaged in a bear market in stocks. And it’s a great way to store your wealth over the long run.
Chris: Thanks for talking, Jeff.
Jeff: Any time.
Editor’s Note: The coming bear market could wipe out U.S. stocks. But as Jeff showed, his trading strategy actually improves when the market panics. Jeff saw gains of 166%, 182%… and even 225% in 2008 – the worst bear market in modern history. He expects to see similar profits in the months ahead. So can you.
Jeff’s inviting a select number of readers to join his options trading service, the Delta Report. He’ll show you which trades to place, how long to hold them, and precisely when to sell. Get the details here.