Crash Test Dummies
"This looks suspiciously like the quiet before the storm"
... Aug 14
"An October-November sell-off is setting up nicely"
... Aug 21
"I just can't get behind a market that continues to make new highs on fewer groups and weak banks"
... Aug 28
"What part of 'sell' don't you understand?"
... Sept 4
"S&P players have yet to come to terms with the fact they are standing alone in a weakening world tape"
... Sep 11
"I now believe an orderly rotation to Value is impossible without first having a correction"
... Sep 18
"As the next year unfolds, the tailwinds of accommodative policy and easy earnings comps will fade, introducing the risk of a valuation re-rating of stocks to bonds."
...Sept 25
"Amazon ...could be losing leadership."
"low volatility we have experienced seems like a beach ball held under water, just waiting to react. I'm on black swan watch now."
... Oct 4
"a correction has produced an environment for a textbook rotational leadership change that the market has needed for months."
... Oct 11
"we need the banks to act well to really find a tradable low"
"don't chase the first bounce here"
... Oct 16
"...the FED moves at its own pace and the December hike is long way away."
... Oct 23
Ok ... so I got what I wanted. Don't say I didn't warn you. Now, smart-ass, where's the bottom?
The correction got vicious yesterday as a weak morning rally reversed into a mechanistic free fall. By afternoon, the rug had been pulled out of the stock market, resulting in a 900+ point reversal in the DJIA. My thoughts went back to that scary Monday long ago 1987. Back then, selling begat selling as computerized trading took over reason.
But don't overthink it. Just like then, it's been mostly sentiment driven. This month, credit markets, commodities and currencies have been relatively calm. This long overdue re-set of relative valuation, although abrupt, is ultimately healthy. Don't forget, 1988 was great year for the global economy.
Corrective action has been setting up for months now. And given how elevated the markets have been this year, the downside potential of the market is substantial. But with FAANG at 37% of the market capitalization of the QQQ, the concept of the "market" was artificial anyway. There are lots of stocks that have corrected fully already.
Computerized algorithms that dominate trading now were initially developed to manage capital more efficiently. But they can create sharp market drops just like traders on the open outcry markets of the past. And don't expect HFT liquidity suppliers to help. Their false liquidity is no buffer when the spread gets crossed. They duck out of the way like a 1970's floor pro who goes out for a smoke.
So drops get exaggerated just as they always have. Risk appetites are just as prone to panics in today's era of computer trading as they were when stocks were first traded under the buttonwood tree.
All this is to say I have no idea where the bottom is. But a few things stood out yesterday. Value equities had great relative performance, rallying strongly against the weakening momentum based "Fang" stocks. This, despite the energy stocks being included in the value group. Its a start.
Relative Performance : Russell Value/Growth
The problem we are having for finding a lasting bottom is, there is no bad news ... and that's bad. We actually need negative economic news to create the motivation for the FED to change its tune and announce a pause. Unlike the 1987 crash and the 1999 correction when Long Term Capital collapsed, motivating Alan Greenspan to inject liquidity, there is currently not enough negative data from either the market or the real economy to prompt the FED to reverse policy.
The stock market has been internally correcting for months, as banks, credit cyclicals and deep industrials have performed poorly. But the FED isn't in the business of propping up markets until either the financial system is threatened or the real economy is noticeably affected.
We are a long way from either of those preconditions.
But don't blame the FED here. They are just doing their jobs. They have never been ones to get ahead of the market and economy. They have been just going along for the ride, like crash test dummies, heading for a sudden stop. And we are currently getting one in the stock market.
Let's hope our friends at the FED are more responsive this time. Until they get the message and signal a pause in their rate hikes, we have more risk to the downside. This morning's POTUS retweet of a sell side analyst arguing for a FED response to the market sell-off may not be helpful. He has politicized the process and thereby tainting any moves in that direction by FOMC. Powell won't be goaded into action by a blowhard like Trump. He needs data.
Bad news is now good news.
Risk Model: 0/5 - MAX Risk Off!
It doesn't get any worse than this. With the XIU dropping below the 95% level with respect to the 200 day moving average, the model reached the maximum risk off level yesterday. That level was last reached in the depths of the 2015-16 mini bear market. This amount of damage will take time to repair. The market may be getting below fair value but we must respect the propensity of investors to get unreasonably bearish in the absence of positive policy developments.
A month-end, Tuesday at 11 style bounce is a possibility if this morning's action is any tell. But a better bottoming pattern would come from a post-election retest of the lows, followed by a basing phase. Some stocks will make their lows here and likely are of the more value oriented variety. Watch for follow-through of yesterday's relative strength in the financials and credit cyclicals in today's tape. They are the most sensitive to the FED pause scenario that is a possible catalyst for a resumption of the bull.