Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the time to sell. -John Templeton
Now that the Standard & Poor’s 500 Index has had its first decline of more than 10 percent since 2011, it is time to assess the technical damage.
There is little doubt the past week has bruised the bull market. Since the run began in March 2009, we have had similar or bigger sell-offs. Quite a few pundits and commentators, though, have said that this one “feels different.” That sort of squishy analysis leaves us too dependent on subjective, unquantifiable emotions. Rather than rely on anyone’s gut feel, let’s spend some time today looking at quantifiable data — market internals, trends, supply and valuations.
I am no longer a trader, and don’t look at internals or technicals much. Instead, I rely on the smartest people I know in the trenches to share their insights. The key take away? The past week has done some serious damage, and whatever recovery we see may be a slog.
Let’s start out with the present, oversold conditions. Jeffrey Saut, chief strategist at Raymond James, points out how unusual the past few weeks have been:
This downside skein has driven the SPX (S&P 500) to roughly 5 standard deviations below its 50-day moving average, a level of oversoldness not seen since the bottom with the Oct. 19, 1987, crash – which was the crash for my generation, and history shows there is only one crash to a generation. Other extremely oversold metrics show the NYSE McClellan Oscillator more oversold than at the March 2009 lows … and the number of stocks above their respective 10/30/50/200-DMAs (daily moving averages) is very low, which is what is seen at major lows.
For those hunting for a bottom, this might be encouraging. But be aware (as noted on Monday) that what’s oversold can always becomemore oversold.
Next up, let’s look at market internals. For that, we go to Stephan Suttmeier, technical research analyst at Bank of America Merrill Lynch. Suttmeier observes that “Monday was a solid 90% down day with 96.8% of stocks down on 97.0% down volume, which comes after two near 90% down days on Thursday and Friday.” As we have seen in the past, based on work by people such as Paul Desmond of Lowry’s, multiple down 90 percent days are what often occurs before any sort of sustainable bottom is reached.
Monday’s selloff was the highest volume day of the year with more than 6.6 billion shares traded on the New York Stock Exchange. That supports the views of Suttmeier and Saut, that this was a climactic sell-off.
The supply issue is paramount to JC Parets of All Star Charts, who noted that “Technical Analysis 101 is a simple study of supply and demand dynamics.” He observes that markets must now deal with the polarity principle. This is when former support (where demand exceeded supply) breaks down. “Support levels have been broken across the board and that former support is likely to become supply on any rally attempts.” Hence, there is a lot of work that needs to be done to return to the highs of May and June.
Perhaps the greatest concern is the long-term trend break. As I see it, this was the greatest technical damage done this month and it will take a lot of heavy lifting to re-establish an uptrend. It’s worse than merely breaking below a 200-day moving average. That’s a noisy series that can be subject to whipsaws. Rather, look at the 10-month moving average — when August ends on Monday, expect to see markets below that indicator. When that happens typically more declines are to come.
A 10 percent decline isn’t fatal; the S&P 500 fell 19 percent in October 2011 and subsequently recovered. However, as Suttmeier observes, it will mean a “period of base-building before a sustainable advance” can occur.
Let’s end on a positive note: Last week, I had lunch with Nicholas Colas of Convergex Group. His daily missive is a must read. He notes that at the very least, stock valuations have markedly improved:
The typical Dow stock now trades for 15.5x this year’s earnings and 14.0x next year. Not cheap, but no longer the 18x earnings we had with the Dow at +18,000. Dividend yields – and every Dow company has a quarterly payout – are 2.3% on the average versus 2.13% for the 10 Year Treasury. Bottom line: market action tells you the next 1,000 points on the Dow may well be lower, but at that point we’re getting to levels where the fundamentals show compelling value.
That doesn’t mean it isn’t going to be bumpy. But here’s what to keep in mind: Stocks may not yet be cheap, but they are getting closer to being reasonably priced.
Originally published as: : How Badly Was the Stock Market Damaged?
Let’s assume the experts have it right so far. Panic low, major volume, etc. Typically this will be followed by a couple of months of general malaise on lower volume before anything really positive can reassert itself. Looking ahead, tax loss selling season might offer more opportunity than usual this year.
I think there’s a whole lot of pain still to come in the energy sector. My understanding is the world market is oversupplied by a few million barrels, and Iran could easily add one million barrels to that within a year, and more over the medium-term. Then you have new technologies like fracking that have still not been widely adopted internationally, and all kinds of new production coming online from long-lead-time projects like the Canadian oilsands. Absent sudden and massive demand growth, I don’t see a major rebound in energy for years. Add to that the transition to other forms of energy over the medium to long term, and it isn’t pretty.
If the above is an accurate assessment, energy stocks still have a long way to fall and some will probably go bankrupt due to all the cheap debt taken on in recent years. Should that happen, it will spill over into the financial sector.
I wonder if the next step in the ongoing asset price fixing exercise/joke is to start buying oil.
I think there already has been a whole lot of pain in the energy sector. We are reaching the point where it just simple is going to lose factor. Demand growth has showed solid acceleration this summer and total “excess” is beginning to shrink. Not that matters for commodity traders. They kept prices silly high for years now they reach the opposite trade.
I am one of those people who should not comment. But this seems to a moment when basic economics work in favor however sluggishly of workers of all income levels while those whose wealth is in investments in stocks are seeing a return to more reasonable assessments of wealth. Would investment in research and workers be the best strategy now
Barry, is it time to trot out that great cartoon, the one that has someone saying “excel” and some one else saying “Sell?” then a thundering herd of “Sell! Sell! Sell!”. In the next pane a trader says in disgust,”This nuts! Good bye!” Some one else says “Buy?” Then the chorus of “Buy! Buy! Buy!”.
My son is in research. He tells me private companies want research but not on their own dime
I think the thing that people tend to forget as we experience things like the last seven sessions is that it is a process. It took a while to get to the place where we broke down, it then typically breaks done much quicker than people expect, especially so with this one. And now we bounce yesterday, as is typical after 6 negative sessions. Today we will have some follow through and perhaps test a resistance level and then at some point, it will go back down. How far? Who knows. But testing the lower supports is also normal. And this process repeats. Up and down.
Maybe it happens quicker and erratically because of algo programs, but those still emulate human behavior traits they were programed with… But, those crazy prices hit on Monday….those were real. Real because the powers that be have put in place rules and those rules beget that action. If you think that the first half hour of Monday was a perfect illustration of what is wrong with the market, either get used to it, are make a call for action. With as much computing power as is on the streets, there is no logical reasons for a first half hour to be that FUBAR. My opinion.
The market didn’t shoot down “out of no where”. It built up to this time. You know, that is why it’s been sideways all year…consolitdating, frustrating, single digit midget…So when it let loose, there was a lot of ooomph! Was it cause by China? Don’t really know. Don’t care. Something was going to trigger it and then get blamed as the cause. The Fed and rates? Debt Ceiling? Lackluster earnings season? Seasonality? China? Commodities? Apple in the “S” cycle of iPhones? How about all of the above? It doesn’t matter, but humans need a reason. Pick one.
I think we will end positively for the year. I think this week showed a very ugly side of the market and of a product type that everyone is in love with now, ETFs. For the investment solution that is supposed to be the low cost panacea of investing, it gloriously illustrated glaring weaknesses in the current rules governing them. Is there a reason an ETF should be able to trade when the underlying constituents are not all open? I would say not, but they did and the rules say that is ok. Didn’t really instill a great confidence in the product for me. Some I use were showing activity of being sold/bought at 50% or more below previous close, and frankly the remainder of the day, on Monday…. That is a huge flaw that I will exploit next time to the best of my ability because I am fairly sure it won’t be fixed, but carefully swept under the rug.
So here’s to the long overdue 10% correction! One less thing for the talking heads to talk mindlessly about. And that is a good thing.
As you say the trend is not good nor is the value. I can’t help wonder when emerging markets will start trending it does seem like there is value there now.