Is there a “colossal financial event” ahead for the markets?

Analysts at Bank of America Merrill Lynch (BAML) certainly do.

They have put together a chart that shows exactly why something big (and bad) is brewing right now.

It’s causing a lot of consternation among investors. But here’s the truth about it and a chart that is far more important.

When “Colossal Financial Events” Actually Happen

The BAML chart is a really simple one that, at first glance, is ominous.

The Business Insider says it’s “a signal a colossal financial event is just around the corner.”

And if you look at it, you’re first reaction will be to agree.

The chart is based on the biggest quarterly moves in the value of the U.S. dollar over the last four decades and their correlation to major market events (source):

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The chart makes the pattern is clear…

Every big move in the U.S. dollar coincided with a major financial event.

The 1987 stock market crash, the Asian currency crisis, the Long Term Capital Management (LTCM) disaster, and Lehman’s collapse in 2008 all coincided with a major move in the value of the dollar.

The chart, however, has one deep flaw. It’s based entirely on quarterly percentage gains and losses for the dollar.

The major financial events which the chart shows played out in far less than than 90 days.

Like the 1987 crash. It lasted about a week.

And the 2008 credit crisis. The chart doesn’t show whether a sharp rise in the dollar came before, during, or after the crisis. preceded the crisis. It just shows the dollar soared in the same three month period the credit crisis occurred in.

This flaw renders meaningless and, therefore, completely useless as a predictor of a “major financial event.”

That didn’t stop the chart from getting attention. It did.

We think it attracted so much attention for another reason other than it’s accuracy. A reason which actually says a major financial event is less like to happen now than it has in years.

Here’s what I mean.

A First in Market History

Take a look at this chart below from TD Ameritrade’s (AMTD).

It’s the company’s Investor Movement Index (IMX) and is a really helpful and accurate indicator of the of investor sentiment.

Basically, if you ever want to know what retail investors are really doing with their money, the IMX will tell you.

Since Ameritrade has so many customers -- 6.3 million funded accounts and $650 billion in assets -- it has a massive amount of data on it’s customers.

And since it’s a discount brokerage, most of its customers are retail investors who are more prone to emotional investing and herd-following than anyone else.

All of this data is compiled to make the IMX.

The chart below compares the IMX to the S&P 500 (source):

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As you can see, the herd has been preparing for a major market event for months now.

As far back as last summer the IMX took a turn for the worse (which means retail investors are selling) and it has been falling ever since then.

That leaves us with either two possible conclusions.

Either the most highly reactionary investors are right for the first time ever or their fears are overblown right now.

Until we see something different, we’ll avoid the patterns-that-aren’t-really-patterns crowd which gave the the deeply flawed U.S. dollar chart prepared by BAML and let centuries of financial market history be our guide.

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