Market Commentary

Volatility is back in the markets and it seems like people can't decide whether to buy or sell.

The Dow Jones Industrial Average broke below 10,000 last week.  Then again, it also crossed right back above that level.  If it seems like 10,000 has been one of the most 'magnetic' 1,000 point thresholds, you are right. On the other hand, is it a meaningful trading level?

All-in-all, May was quite a month!  We saw a "flash crash", followed by a 400-point
relief rally, followed by a slow motion free-fall, followed by a nearly
300-point rally. The cherry-on-the-top was last Friday's triple-digit
drop going into the long weekend.

Putting the Dow's Drops and Rebounds in Perspective.

The market's recent "flash-crash" ranks as the largest point-wise drop in history. But how does it stand up percentage-wise; and how many drops greater than 5% have we seen? Minyanville posted a visualization of the data (going back to 1928) that answers those questions. Click to the graphic for an interactive version.

One other point worth noting, historically, big gaps and daily rallies occurred most often in the context of bear markets.  They are not usually a sign of impending calm waters or smooth sailing.

Nonetheless, we've seen a decent pull-back and there are signs that the short-term might offer some upside bias.

Recently, Bearish Spikes Have Provoked Bullish Responses.

Bespoke reports that this week's sentiment surveys from Investors Intelligence and
the American Association of Individual Investors showed
sharp increases in bearish sentiment among both advisors and individual
investors.  The chart below compares the S&P 500 with bearish sentiment since the
start of 2009.  The current level of combined bearish sentiment is the
highest since the start of November.  As shown in the chart, since the
market bottomed back in 2009, spikes in bearish sentiment have actually
turned out to be pretty good buying opportunities.

So, let's look at the market.  Short-term, here is David Singer's
bullish case for the S&P.  It is drawn on a 60-minute chart, and shows a series of head and shoulder bottom patterns.  The implication is for a rally that measures the same distance as from the neckline to the head.

Longer-term, Singer shows a potential head and shoulders topping pattern on a daily view of the S&P 500.  Click it to see a
larger version.

We'll see. Hope you have a good week.

Business Posts Moving the
Markets that I Found Interesting This Week:

Volatility is back in the markets and it seems like people can't decide whether to buy or sell.

The Dow Jones Industrial Average broke below 10,000 last week.  Then again, it also crossed right back above that level.  If it seems like 10,000 has been one of the most 'magnetic' 1,000 point thresholds, you are right. On the other hand, is it a meaningful trading level?

All-in-all, May was quite a month!  We saw a "flash crash", followed by a 400-point
relief rally, followed by a slow motion free-fall, followed by a nearly
300-point rally. The cherry-on-the-top was last Friday's triple-digit
drop going into the long weekend.

Putting the Dow's Drops and Rebounds in Perspective.

The market's recent "flash-crash" ranks as the largest point-wise drop in history. But how does it stand up percentage-wise; and how many drops greater than 5% have we seen? Minyanville posted a visualization of the data (going back to 1928) that answers those questions. Click to the graphic for an interactive version.

One other point worth noting, historically, big gaps and daily rallies occurred most often in the context of bear markets.  They are not usually a sign of impending calm waters or smooth sailing.

Nonetheless, we've seen a decent pull-back and there are signs that the short-term might offer some upside bias.

Recently, Bearish Spikes Have Provoked Bullish Responses.

Bespoke reports that this week's sentiment surveys from Investors Intelligence and
the American Association of Individual Investors showed
sharp increases in bearish sentiment among both advisors and individual
investors.  The chart below compares the S&P 500 with bearish sentiment since the
start of 2009.  The current level of combined bearish sentiment is the
highest since the start of November.  As shown in the chart, since the
market bottomed back in 2009, spikes in bearish sentiment have actually
turned out to be pretty good buying opportunities.

So, let's look at the market.  Short-term, here is David Singer's
bullish case for the S&P.  It is drawn on a 60-minute chart, and shows a series of head and shoulder bottom patterns.  The implication is for a rally that measures the same distance as from the neckline to the head.

Longer-term, Singer shows a potential head and shoulders topping pattern on a daily view of the S&P 500.  Click it to see a
larger version.

We'll see. Hope you have a good week.

Business Posts Moving the
Markets that I Found Interesting This Week:

It's time to talk about American Idol (with the Finale this week, and all). 

Sorry, my mistake … another bad jobs numbers came out & the markets went down … so it is time to talk about the American Idle.

Last week was rough for the bulls; and if not for a reversal after the opening bell on Friday, it would have been a lot worse. Consider this: The Russell 2000 gained 2.5% after the open on Friday and still finished with a 6.44% loss for the week. So, yes, it could have been a lot worse.

Was That a Key Reversal Day in the Markets Last Friday?

The S&P Index 500 technically complied with all the rules of a "key reversal day." It plunged to a new low of a significant decline. It then rallied up on increasing volume, and closed well above the prior close.

And here is a longer-term chart showing the S&P on a weekly basis.

We will see if there is some buying triggered here.  If the bull-market swing is to continue it has to kick-in soon.

But Where Is the Selling Pressure?

With the market in a dizzying decline, why haven't we seen more committed bearish bets? Are traders going flat instead of short?

One reason is discussed by Carl Swenlin. His assumption is that bull market declines will be short-lived, and that a neutral signal eliminates market exposure during a correction, while at the same time addressing the lower probability outcome of a full bear market decline. In other words, we never know if a bull market correction will actually be the beginning of a new bear market, but we do know that most of the time it won't be, so it makes sense to bet with the odds and go neutral.

A Dash of Insight.

I saw a list that I wanted to share.  It from the Dash
of Insight blog, which is a consistently good source of information.  Here is an excerpt.

"I am pretty fussy about economic news related to jobs and housing, and I did not like what I saw.

• I closely watch building permits as the best leading indicator of new construction.  Construction is up (reflecting the tax credit, which has now expired) but building permits were down 11.5%.
• The BLS report on Business Dynamics showed job losses for the quarter ending in Sept., 2009, were about 300K worse than expected.  You will not see this news anywhere else.  Even though this is an "old" report, people should watch it as a way of verifying the accuracy of the "official" BLS payroll employment report projections.  Basically, this is an early read on eventual "benchmark" revisions.  There was plenty of job creation, including a million jobs from new establishments, but still not as much as estimated.  More detail is beyond the scope of this weekly summary, but those interested can get the essentials of the argument in my analysis of the November report (different time, same issue).
• The uptick in initial claims was also a negative for jobs.  We really need to see progress on reduced layoffs and more job creation.  Both seem to have stalled.
• The S&P 500 broke the 200-day moving average.  Many people view this as the most important technical indicator, keeping them on the right side of major trends.  This is being quoted as 1102 or so, and is something to watch.
• The ECRI indicators are in the growth area, but weaker than in past weeks.  Their interpretation?  "With WLI growth sinking further to a 43-week low, U.S. economic growth is set to start easing in fairly short order."  This seems to be an unusually strong emphasis on a "second derivative" interpretation of a strong reading, but it is their index.  I look at their numbers, but also at their own interpretation.

The high volatility in trading is frightening to nearly all investors.  Thursday was especially bad.  The extremely late rally on options expiration day makes the week's pricing look a bit better, but most observers will need much more convincing."

VIX Approaches Pre-2008 Record Highs

The Volatility Index is spiking.

When the VIX rises as it's done the past two weeks, emotions rule the market.

Bill Luby found that, prior to 2008, the VIX only managed to nudge its way over a reading of 45 on three instances:

• the Long-Term Capital Management crisis;
• the Russian Financial Crisis that preceded the LTCM debacle; and
• the height of the dotcom crash, when WorldCom filed for bankruptcy.

The table below summarizes the top ten pre-2008 VIX closing highs. Last week’s VIX spike to 45.21 would put it at #3 all-time outside of the 2008 financial crisis.

It's time to talk about American Idol (with the Finale this week, and all). 

Sorry, my mistake … another bad jobs numbers came out & the markets went down … so it is time to talk about the American Idle.

Last week was rough for the bulls; and if not for a reversal after the opening bell on Friday, it would have been a lot worse. Consider this: The Russell 2000 gained 2.5% after the open on Friday and still finished with a 6.44% loss for the week. So, yes, it could have been a lot worse.

Was That a Key Reversal Day in the Markets Last Friday?

The S&P Index 500 technically complied with all the rules of a "key reversal day." It plunged to a new low of a significant decline. It then rallied up on increasing volume, and closed well above the prior close.

And here is a longer-term chart showing the S&P on a weekly basis.

We will see if there is some buying triggered here.  If the bull-market swing is to continue it has to kick-in soon.

But Where Is the Selling Pressure?

With the market in a dizzying decline, why haven't we seen more committed bearish bets? Are traders going flat instead of short?

One reason is discussed by Carl Swenlin. His assumption is that bull market declines will be short-lived, and that a neutral signal eliminates market exposure during a correction, while at the same time addressing the lower probability outcome of a full bear market decline. In other words, we never know if a bull market correction will actually be the beginning of a new bear market, but we do know that most of the time it won't be, so it makes sense to bet with the odds and go neutral.

A Dash of Insight.

I saw a list that I wanted to share.  It from the Dash
of Insight blog, which is a consistently good source of information.  Here is an excerpt.

"I am pretty fussy about economic news related to jobs and housing, and I did not like what I saw.

• I closely watch building permits as the best leading indicator of new construction.  Construction is up (reflecting the tax credit, which has now expired) but building permits were down 11.5%.
• The BLS report on Business Dynamics showed job losses for the quarter ending in Sept., 2009, were about 300K worse than expected.  You will not see this news anywhere else.  Even though this is an "old" report, people should watch it as a way of verifying the accuracy of the "official" BLS payroll employment report projections.  Basically, this is an early read on eventual "benchmark" revisions.  There was plenty of job creation, including a million jobs from new establishments, but still not as much as estimated.  More detail is beyond the scope of this weekly summary, but those interested can get the essentials of the argument in my analysis of the November report (different time, same issue).
• The uptick in initial claims was also a negative for jobs.  We really need to see progress on reduced layoffs and more job creation.  Both seem to have stalled.
• The S&P 500 broke the 200-day moving average.  Many people view this as the most important technical indicator, keeping them on the right side of major trends.  This is being quoted as 1102 or so, and is something to watch.
• The ECRI indicators are in the growth area, but weaker than in past weeks.  Their interpretation?  "With WLI growth sinking further to a 43-week low, U.S. economic growth is set to start easing in fairly short order."  This seems to be an unusually strong emphasis on a "second derivative" interpretation of a strong reading, but it is their index.  I look at their numbers, but also at their own interpretation.

The high volatility in trading is frightening to nearly all investors.  Thursday was especially bad.  The extremely late rally on options expiration day makes the week's pricing look a bit better, but most observers will need much more convincing."

VIX Approaches Pre-2008 Record Highs

The Volatility Index is spiking.

When the VIX rises as it's done the past two weeks, emotions rule the market.

Bill Luby found that, prior to 2008, the VIX only managed to nudge its way over a reading of 45 on three instances:

• the Long-Term Capital Management crisis;
• the Russian Financial Crisis that preceded the LTCM debacle; and
• the height of the dotcom crash, when WorldCom filed for bankruptcy.

The table below summarizes the top ten pre-2008 VIX closing highs. Last week’s VIX spike to 45.21 would put it at #3 all-time outside of the 2008 financial crisis.

Enticing the Crowd Back to the Markets With "You Can't Win If You Don't Play".

After the "flash crash", the markets recovered quickly and then sold off again, ending that week with additional selling pressure. While some people might have seen that volatile move down as a buying opportunity, many others saw it as a place to get short (or at least to take some risk off the table).

The result was heavier shorts and lighter longs going into the beginning of last week.

For those of you that believe in the "Plunge Protection Team" (which isn't quite the same as believing in the Tooth Fairy), then it probably wasn't surprising to find the markets gapping higher to start trading last Monday. Nonetheless, you might have been surprised to find that the gap was close to 4%.

It All Depends on How You Look At It.

Once again, different types of traders will interpret that as a threat or an opportunity.

The Bear:  Some consider "expecting gaps to close" to be a high probability trading setup. Consequently, a big gap-up offers an opportunity to enter a short position with a well defined stop. Add the increased volatility, and the bears were frothing at the mouth.

The Bull:  This type of trader would notice that a 4% gap is very different than a half percent (or a even a one percent) gap. Consequently, they expect massive short covering from all the bears trapped in their short positions from the week before. Therefore, they are looking to buy the gap (instead of shorting it).

Imagine the arguments at trading desks around the world as they try to figure out whether this pattern was part of a market top or the sign of a continuation rally.

Obviously, the markets continued higher. This forced more shorts to
cover, and also disturbed traders who wanted to buy, but didn't because
of risk concerns.

The Skeptic:  That brings up a third type of trader, someone who was sitting on cash because their trading systems work well during normal market conditions (but who suspects that these are not normal market conditions because of the volatility and exogenous threats).

So, Wednesday comes and it is clear that the markets have been trending higher.  Now imagine the conversations at the trading desks of the people who are sitting-out these big swings. They are getting pressure from their bosses and their clients to ask why they are missing these "easy" trades.

It's easy to go to cash, but when do you get back in? How do you determine when it's safe to get back in the water?

Is It Safe?

And there are signs that something "different" is happening.  Here is a video from Jason Leavitt.

 

Learned
Behavior.

Many of the algorithmic firms got burned
during the last period of unusual volatility. They have the benefit of
sophisticated back testing and analysis tools. You'd expect them to
develop new rules to reduce their exposure, or at least a switch which
systems are using in the markets.  So their behavior shouldn't be surprising.

Pick Your Poison.

Going back to the folks who believe in the Plunge Protection Team, as I've discussed before, it makes sense for the government to move the markets higher during periods of light trading. It accomplishes their goal with the least cost.

Because it's supposedly a free market, if people disagree with higher prices … it will trigger selling. At this point, it appears that we are getting close to the area that will trigger selling.  Moreover, I don't think it is in the government's interest to prevent that from happening. Nonetheless, there is a lot of backstage maneuvering going on right now to prevent heavy selling.

So traders now have a different decision in front of them. On one hand, they know it isn't often profitable to fight the Fed. On the other hand, in the long run, it's even harder to fight human nature. Markets can be pushed a little this way or that; but for how long?

And our government isn't the only one facing tough choices.

Greece Is The Word, At Least For A Little Longer … Then It Might Be PIIGS.

Paul
Kedrosky posted a chart showing that this time is different.  
Behold the immensity and the singularity of Greece’s sovereign debt
& fiscal adjustments.

Next, take a look at this.  The NYTimes came up with an interesting graphic depicting Europe's web of debt. 

As the Atlantic
points out, it's not just the case that these countries are running
huge deficits. It's also worrying that they owe each other tens of
billions of dollars. Greece owes $10 billion to Portugal. Portugal owes
$86 billion to Spain. Spain owes more than $200 billion to both France
and Germany. If Greece defaults, it's not clear where the domino effect
stops.

Enticing the Crowd Back to the Markets With "You Can't Win If You Don't Play".

After the "flash crash", the markets recovered quickly and then sold off again, ending that week with additional selling pressure. While some people might have seen that volatile move down as a buying opportunity, many others saw it as a place to get short (or at least to take some risk off the table).

The result was heavier shorts and lighter longs going into the beginning of last week.

For those of you that believe in the "Plunge Protection Team" (which isn't quite the same as believing in the Tooth Fairy), then it probably wasn't surprising to find the markets gapping higher to start trading last Monday. Nonetheless, you might have been surprised to find that the gap was close to 4%.

It All Depends on How You Look At It.

Once again, different types of traders will interpret that as a threat or an opportunity.

The Bear:  Some consider "expecting gaps to close" to be a high probability trading setup. Consequently, a big gap-up offers an opportunity to enter a short position with a well defined stop. Add the increased volatility, and the bears were frothing at the mouth.

The Bull:  This type of trader would notice that a 4% gap is very different than a half percent (or a even a one percent) gap. Consequently, they expect massive short covering from all the bears trapped in their short positions from the week before. Therefore, they are looking to buy the gap (instead of shorting it).

Imagine the arguments at trading desks around the world as they try to figure out whether this pattern was part of a market top or the sign of a continuation rally.

Obviously, the markets continued higher. This forced more shorts to
cover, and also disturbed traders who wanted to buy, but didn't because
of risk concerns.

The Skeptic:  That brings up a third type of trader, someone who was sitting on cash because their trading systems work well during normal market conditions (but who suspects that these are not normal market conditions because of the volatility and exogenous threats).

So, Wednesday comes and it is clear that the markets have been trending higher.  Now imagine the conversations at the trading desks of the people who are sitting-out these big swings. They are getting pressure from their bosses and their clients to ask why they are missing these "easy" trades.

It's easy to go to cash, but when do you get back in? How do you determine when it's safe to get back in the water?

Is It Safe?

And there are signs that something "different" is happening.  Here is a video from Jason Leavitt.

 

Learned
Behavior.

Many of the algorithmic firms got burned
during the last period of unusual volatility. They have the benefit of
sophisticated back testing and analysis tools. You'd expect them to
develop new rules to reduce their exposure, or at least a switch which
systems are using in the markets.  So their behavior shouldn't be surprising.

Pick Your Poison.

Going back to the folks who believe in the Plunge Protection Team, as I've discussed before, it makes sense for the government to move the markets higher during periods of light trading. It accomplishes their goal with the least cost.

Because it's supposedly a free market, if people disagree with higher prices … it will trigger selling. At this point, it appears that we are getting close to the area that will trigger selling.  Moreover, I don't think it is in the government's interest to prevent that from happening. Nonetheless, there is a lot of backstage maneuvering going on right now to prevent heavy selling.

So traders now have a different decision in front of them. On one hand, they know it isn't often profitable to fight the Fed. On the other hand, in the long run, it's even harder to fight human nature. Markets can be pushed a little this way or that; but for how long?

And our government isn't the only one facing tough choices.

Greece Is The Word, At Least For A Little Longer … Then It Might Be PIIGS.

Paul
Kedrosky posted a chart showing that this time is different.  
Behold the immensity and the singularity of Greece’s sovereign debt
& fiscal adjustments.

Next, take a look at this.  The NYTimes came up with an interesting graphic depicting Europe's web of debt. 

As the Atlantic
points out, it's not just the case that these countries are running
huge deficits. It's also worrying that they owe each other tens of
billions of dollars. Greece owes $10 billion to Portugal. Portugal owes
$86 billion to Spain. Spain owes more than $200 billion to both France
and Germany. If Greece defaults, it's not clear where the domino effect
stops.