There are three things happening right now that will define the S&P 500 in 2021 as we close out this year.
1)Margin debt is now hitting a record high. American stock market investors have now borrowed over $700 billion against their own portfolios to buy more stocks. This creates a massive risk in the markets, because when you get people borrowing money to buy stocks whenever the market does turn down such people end up selling in panic and if they don’t sell and things go down enough (usually 20%) then their brokers force them to sell.
At the same time much of this buying is driven by people with little experience in the markets at all. This is a year in which MILLIONS of new traders got into the market for the first time thanks to apps such as Robinhood, which has said that over ten million new people opened accounts with them this year.
Most of these accounts were opened after May with people using stimulus money so these people have never seen a stock market drop of over 10%.
This is all a risk that will one day blow up, but it isn’t happening now, because….
2)While 2020 was defined by massive stock market volatility with a S&P 500 drop of over 33% in March and then a subsequent rally over over 70% from that low point, market volatility is actually now fading.
The Bollinger Band width indicator is a simple indicator that measures the true price volatility on a chart.
The Bollinger Band width indicator on the bottom of this chart is actually now trading at its lowest point for 2020, meaning that 20-day volatility has collapsed.
The market can continue to trade with shrinking volatility for months and I believe it will as I said in a video I put on youtube a few weeks ago.
3) At the same time as true price volatility is falling the VIX is still trading above 20, to show us that when it comes to traders hedging in the options market they are paying for a higher volatility premium than is justified by actual real price volatility.
I expect we’ll see the VIX go to 15 or below before we see a real decline in the stock market.
So what does all of this mean?
I expect we’ll see the market continue to trade the way it has in the past few weeks with falling volatility while investors take on greater risks, when it comes to buying more on margin, buying more call options, and buying riskier stocks and then at some point next year, probably in the second half, things will blow up on them again.
Until then it can and should be smooth sailing and if you try to point out to people that buying on margin is risky those doing it for the first time will only yell at you. This seems to be a game where people only can learn from their own hard lessons, but the reality is that the American economy is suffering like it is in a depression and many people are in the stock market to try to gamble to live.
A stagnate economy and rising stock prices thanks to Fed debt creation and now borrowing activity by manic if not desperate investors is how we close out 2020.
-Mike
