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What to Make of the "Supreme Confidence in Financials"

Will the financial sector turn down before the broader market?

by Bob Stokes
Updated: April 11, 2017

In 2007, the KBW Bank index turned down months ahead of the DJIA. In 2017, optimistic expectations are again running high for the financial sector. Ironically, history shows that investors should be the most worried when financial fear is absent. Let's review today's position of the "fear index" VIX and KBW Bank Index.

 

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[Editor's Note: The text version of the story is below.]

Confidence is generally considered a desirable trait. But when it comes to financial markets, watch out!

Add complacency to the mix, and you have a sentiment brew that will turn Wall Street princes into frogs.

Going back to February 2007 will give you a clear idea of what I'm talking about. Then, the CBOE Volatility Index, VIX, -- or, the "fear index," as it's also known -- had exhibited extremely low readings, indicating a near absence of fear. Indeed, on Feb. 14, 2007, the index had hit an intraday low of 9.70.

The following month, our March 2007 Elliott Wave Financial Forecast said:

The CBOE Volatility Index (VIX) closed the week of February 12, 2007 at 10.02, its third lowest close in history. The first and second lowest closes came December 1993 and January 1994, right before a sharp 11% market decline.

The historic top in the DJIA  didn't arrive until October 2007, but the broad index did fall 6.7% from mid-February through early March of that year. The bank index did top in February 2007, and fell 85% through March 2009.

So, how is all of this relevant today?

Well, review this chart and commentary from our current, April 2017 Elliott Wave Financial Forecast:

The VIX is on track to register its lowest quarterly average since the final months of 2006. The horizontal arrows on the chart of the KBW Bank Index show that the VIX's return to the same low range as late 2006, early 2007 may be significant. The Elliott Wave Financial Forecast noted in May 2008, "High volatility tends to follow low volatility." The financial sector at times leads the transition.

At the recent March 1 high, optimistic expectations for the financial sector are close to where they were in early 2007: "Regulatory reform could be a significant driver in higher bank earnings," says a recent research report. "Tax Reform Could be a Boon for Financials," says another. ... The air of supreme confidence in financials was part of the reason EWFF identified 2007 as the "Year of Financial Flameout."

Our analysts are also reviewing indicators that suggest the financial sector could once again see a downturn before the broader market.

For risk-conscious investors, this is an ideal time to review those indicators, too.

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