Several
weeks ago, I wrote a note
explaining why the bottoms that were hit in mid-October were most likely not
the lows for the year. I offered several reasons why that I believed that to be
the case.
I turned out
to be incorrect.
The U.S.
equity markets completely shrugged off any and all concerns regarding the end
of QE, slowing global economies, geopolitical tensions and Ebola and pushed to new
annual highs.
It would
appear the bulls remain in charge but what has really raised an eyebrow or two
is the amount of “skittishness” there appears to be in the market. In my humble
market experience, I can’t recall a time when a correction came and went in
such quick measure. I am shocked at how quickly the market pivoted from
euphoria – to panic – back to euphoria.
Subjectively
speaking, it felt like there was clearly panic in the air. There were so many
that felt this was the beginning of the end of the QE empowered rally that
started in 2009.
I wanted to
take a more objective approach in reviewing this flash correction and started
looking at the five day volatility for the volatility index (vix) since his
rally began. I simply took the range of the five day high and low for the vix
to measure market fear. I found two other instances when the vix swung so
wildly. They were August of 2011 and May of 2010.
On August 9,
2011 the vix swung from 23.38 to 48.00 over five days. On May 7, 2010 the vix
had a five day range of 20.19 to 40.95. On October 14, 2014 the vix had a range
of 15.11 to 24.64.
The prior
two excessive volatility periods resulted in a pullback in the bull market but
offered an opportunity to build positions as the market remained depressed for
a period of weeks and months. This time around, bullish sentiment returned so
quickly that the correction barely registered on a longer-term stock chart.
The wild
swing in the put-call ratio also confirmed the increased skittishness. The
ratio went north of 1.5, the highest level in years as investors sought
downside protection for their portfolios. Then just as quickly the ratio dropped to
around .75 as if nothing happened. On the surface one can call this a
correction but it sure didn’t feel like one.
There are
other extraordinary facts about this latest correction that has many talking.
Taken from the blog The
Fat-Pitch, here are more really interesting points.
“This market is well-known for doing
the unprecedented. According to SentimentTrader, SPX traded more than 0.5%
above its 5-dma for 10 days in a row in the past two weeks. In the prior 75
years, this has only happened twice before, both at bear market lows (1982 and
2002). In other words, a rare rip higher, that has only happened after
multi-year bear markets, just occurred after a mild, four week drop. It's
incredible and completely unexpected.”
More from The
Fat Pitch, “Perhaps the most
distinguishing characteristic of the current rally is this: SPX has made a series
of 12 daily "higher lows" in a row. According to Paststat, there have
been only 9 other instances in the past 20 years where SPX has made more than
10 "higher lows" in a row (post). This raises the question of what
typically happens next.” It turns out that the S&P 500 has struggled or
went lower in 7 of the 9 instances
While
parsing through the numbers, I realized just how CRAZY investor sentiment has
been over the last few weeks.
Last week, the
survey produced 52.7% of respondents saying they are “bullish” towards the
market and only 15.1% claimed to be “bearish. These results are at extreme
levels.
Looking at
the next figure, going back to 1987, there is typically an average spread
between bulls and bears of about 8.5 points, in favor of the bulls. As of the
latest reading, there exists a 37.6
point spread between the two almost two standard deviations from the norm.
Displayed a
different way, I take a ratio of bulls-to-bears. There is historically 1.5
bulls to every bear. The reading from last week shows a margin of 3.5 bulls for
every bear. This is an enormous misalignment to historic norms and should be
considered an outlier.
Another item
to note has been the rate of change from bearish to bullish. Similar to the extreme
moves in the vix and the put-call ratio, the AAII investor Sentiment survey has
seen an aggressive increase from the mid-October correction.
During the
correction, the bulls-to-bears ratio was around 1.2 and spiked to 3.5 in four
weeks. The last time we saw such rapid changes in the survey was late 2005 into
early 2006.
While our
call from several weeks ago turned out to be erroneous, we are still cautious
for the outlook on equities. While it is difficult to tell how effect the post-election euphoria skewed these figures our belief is that this pendulum will swing in the opposite direction
at some point.
Joseph S.
Kalinowski, CFA
Joe@squaredconcept.com
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