Over the past few weeks we have been highlighting a number of indicators suggesting that the stretched bull market in equities is due for a correction. We weren’t sure what might spook the market, but today’s geopolitical events certainly qualify.

After weeks of increased rhetoric between North Korea and the US, the UN applied heavy sanctions against North Korea in response to its recent tests of intercontinental ballistic missiles.

In a statement carried by the official KCNA news agency, the North Korean government said the sanctions were a “violent violation of our sovereignty” and part of a “heinous plot to isolate and stifle” the country. Pyongyang threatened to take “righteous action”, describing the sanctions as a crime for which the US would pay “thousands of times”.

US president Trump then upped the ante, saying “North Korea best not make any more threats to the United States,” Trump told journalists. “They will be met with fire and the fury like the world has never seen.”

Not to be outdone, the North Korean regime quickly responded, matching Trump’s pugnacity by saying it was “carefully examining” a plan for a missile strike on the US Pacific territory of Guam. In a separate statement, a military official was quoted as saying Pyongyang could carry out a pre-emptive operation if the US showed signs of “provocation”.

The Asian markets were the first open and sold-off at the bell. Things calmed toward the close, with most markets down slightly, and Japan’s Nikkei seeing the biggest hit, down 1.29%.

European markets opened next and followed the same pattern with all markets down. Similar to Asia, most markets recovered some of those losses by the close. The French CAC market saw the biggest decline, down 1.40%.

North American markets were last to open and followed the same pattern, opening down, and then slowly regaining much of those losses. Despite the disturbing headlines, investors chose to re-focus on the economy and the buyers returned. By the close, the S&P 500 was only down .04%.

While the technical stocks in the NASDAQ took a bigger hit, down .28%.

On the currency side, the Japanese Yen was the safe haven play, up .33%.

And as is the case with most geopolitical  tensions, the precious metals were big gainers, with gold up 1.32%, and silver the biggest gainer at 2.89%.

Generally, the well-known trading adage “Sell in May and go away” works, as long as you re-enter the market at the right time. This year however, the markets have been strong and are higher today than they were in May, driven primarily by the strong rally in July.

As we can see on the Seasonality Chart below, a July rally is the norm, not the exception. Based on data from the past 20 years, it is the month of August that typically sees a strong correction. September tends to follow with a rally to start the month, then sell-off into October. It is mid October where we generally see the market pick up again, with a year-end rally.

We are still long, but just entered an “insurance” trade in case we do get that seasonal correction heading into September.

Stay tuned!

Mariam Webster’s definition of Complacency:  marked by self-satisfaction especially when accompanied by unawareness of actual dangers or deficiencies :  marked by complacency :  self-satisfied a complacent smile

The VIX volatility Index measures the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking, is calculated from both calls and puts, and is a widely used measure of market risk, often referred to as the “investor fear gauge.”

A VIX reading above 30 indicates that investors are nervous, fearful, and risk-averse, concerned that the markets will decline. While readings under 20 indicate that investors are complacent, risk-tolerant, and optimistic that the markets will run higher. As we can see on the VIX charts below, investors are more complacent/optimistic today than at almost any other time in history.

Another indicator that we need to pay attention to is that the S&P 500 seldom deviates more than 7% from its 200-day Moving Average. As we can see on the following chart, once the S&P 500 deviates up or down more than 7%, we tend to see a correction the other way. Today the S&P 500 is trading at 6.91% higher than its 200-day MA, suggesting a correction is coming.