Now What?

Following an extended period of prices steadily ratcheting higher, the stock markets finally collectively hit some wild turbulence.  The speed and ferocity of the past week’s decline was alarming particularly because over the past 2 years, people have been lulled into believing that a steady, low volatility advance was the new normal.  In fact, it was this period of historically low volatility that was unusual.  From the beginning of what we’ll call the Trump rally in early 2016 up until just the week past in 2018, the equity markets have marched steadily higher in the absence of any correction of note.  For anyone who’s been involved in stock markets for more than just a few years, that was the unusual event.

A chart of VIX, the CBOE’s volatility index shows just how dramatic this sudden change was:

We’d mentioned in an earlier post that this volatility index actually traded below 9 before the parabolic spike that just recently occurred.  I’m reminded of that old movie cliché, “It’s quiet in here….too quiet..”

We can discuss the whys and wherefores of these volatility extremes, but certainly one factor is the increased concentration of money in the hands of fund managers and in particular with the explosion of ETF products over the past generation.   As ETF’s have become popular proxies for investors, purchases and sales of sector stocks are exaggerated by mandated index buying, or in the recent case, selling by these funds.  There appears to be an ETF for every conceivable sub sector of the stock market, allowing investors to zero in on their favored areas.   There are practically as many ETF’s as there are stocks, which if you think about it seems bizarre.  Among those are some very exotic and esoteric ones. With the recent volatility, one of the particularly exotic ones, SVXY, suffered a total collapse.  This ETF was created to be short volatility, or betting that the markets would not swing. They actually got people to invest in this, a product which in Wall Street parlance is ‘picking up pennies in front of steamrollers’.

Meanwhile the rest of the stock markets, domestically and internationally, experienced the long expected correction and it seemed to happen all at once, spurring the usual hysteria among market pundits.  Any time you hear about people proclaiming the markets to be either rational or irrational it betrays their ignorance of how markets work. While rationality may explain value, it falls well short of explaining price movements.  Markets are all about expectations which themselves are a function of good old fashioned fear and greed.

We can observe that the price action of the QQQ ETF, a proxy for the Nasdaq stocks, sold off with a huge spike of volume at the end of last week.

 

We observe that the price spike on the downside stopped at or near the threshold of what was once considered resistance, now turned into support.  What’s most interesting is the behavior of the last bar, which is clearly a long legged doji candle.  This particular bar is significant because it can show when prices have bottomed after a panic sell off.  Since this is formed at a significant level of support with climactic volume, there is a strong clue that, as long as this level is not penetrated on the downside, the bottom may have been made for this selloff.  Chart patterns of the Dow and the S&P show a similar configuration, thus for the time being, the brunt of the selloff appears to be complete.  At worst,we expect that the low may be tested but with nowhere close to the volume that we’ve seen over the past week.

When this occurs, we can expect the momentum statistics to turn to the upside making long trades less risky.  We are not of the opinion that the selloff has signaled the end of this particular bull run.  Historically, tops are made when there are significant momentum divergences at highs.  Thus far, there is insufficient evidence to support that and it appears that the advance over the past 2 years is perhaps an Elliot wave 3. However, we do expect going forward that the advances in the market may become narrower and that other sectors of the market will lead.

 

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