Whenever we see stock prices dropping, the question that runs through all of our minds is this: “Are we seeing a short-term pullback, or are we seeing the beginning of a new bearish trend?”
This is an incredibly difficult question to answer. In fact, it’s virtually impossible to answer at the beginning of a turnaround. The best we can do is watch and see how the turnaround plays out over time.
However, there are some clues we can watch for along the way that can help point us in the right direction. Some of those clues revolve around the idea of a “flight to safety.”
When investors become increasingly nervous about the potential losses they may be exposed to by investing in riskier assets, such as small-cap stocks, emerging-market equities and leveraged currency trades, they tend to move their money from those areas to safer assets, such as U.S. Treasuries and defensive stocks. At the same time, they tend to buy protection for the riskier parts of their portfolios, which shows up in indicators like the CBOE Volatility Index (VIX).
By monitoring these asset classes, we can get a better idea of whether we are seeing a short-term pullback or a new bearish trend. We’ll take a look at some of those clues now, but to try to keep things in perspective, we are going to look at weekly charts.