The odds of Australian stocks falling into a bear market, in one chart

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Australian stocks have enjoyed a solid run recently, especially this month.

The benchmark ASX 200 index has risen 4.5% over the past month, extending its rally from Donald Trump’s victory in the US presidential election last November to 17%.

However, while the index is higher, it hasn’t exactly been the most exciting time for Australian investors, particularly for traders who are craving even the smallest skerrick of market volatility.

Nothing quite demonstrates just how quiet it’s been than the chart below from Deutsche Bank, revealing the number of days per month that the ASX 200 has moved more than 1% in either direction.

Source: Deutsche Bank

It’s been slim pickings for those looking for a bit of excitement, and helps explain why the ASX 200 Volatility Index, or VIX, currently remains anchored near the lowest levels on record.

The VIX uses options pricing to determine expected market volatility looking a month ahead.

After such a solid run higher, it’s understandable why some may see this quiet period in Australia’s stock market as the calm before the storm.

Does it suggest that something sinister lies just around the corner, paving the way for a significant decline in stocks?

No one knows that answer for sure. So-called “Black Swan” events are, by their very definition, seen as impossible to predict.

However, based on other market indicators, Tim Baker and David Jennings, strategists at Deutsche Bank’s Australian equities team, suggest the likelihood of a large pullback in stocks in the months ahead is currently next to nothing.

This next chart explains why. It’s Deutsche Bank’s Australian Equities Bear Market Indicator.

Source: Deutsche Bank

The indicator uses equity valuations, earnings growth, interest rates and cross-asset market indicators to help predict when bear markets, defined as Deutsche as a pullback of at least 15%, are likely to occur within the next six to 12 months.

Given it’s track record for predicting bear markets in the past, shown in the grey shaded areas, it appears the medium-term outlook is looking alright for Australian stocks.

“Overall, the model only sees a 5% chance of a bear market in the next six months,” says Baker and Jennings. “Whenever the probability for a bear market has been below 10%, Aussie equities have risen by 5% on average over the subsequent six months.”

Baker and Jennings see the ASX 200 trading at 6,000 by June 2018. It currently sits at 5,897.50.

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