Tuesday, April 7, 2015

Bad News is Still Good News

I, like most everyone else, expected the market to sell off when we opened Monday morning.  The futures market moved sharply lower on Friday in response to the huge jobs number miss.

But what is the market telling us when we expect one thing yet get the complete opposite reaction? Stocks gapped down on the open and then never looked back as we rallied all day to close significantly higher.  What it tells me is the bid underneath this market remains strong.  Why it remains strong is another topic.  But if we just look at price behavior, the indexes appear to want to grind higher.  I still think we'll have a bigger correction than 7% in the broad market at some point this year but apparently not right now.

We could get a test of the upper range in the S&P (2120) as we recently tested the lower boundary (2040) and held successfully.  Either way I don't think it will be easy.  Keep in mind we have earnings coming up toward the end of the month that will create volatility in both  directions.  Until we get a significant break of the range-bound lows this should continue to be a buy-the-dip market.

With "Buy-The-Dip" in mind, we wanted to run a study looking at short-term returns when using such an approach.  Below, we looked at buying the S&P 500 when the % of stocks above their 10-day moving average was at various points (which we broke into quartiles).  The results show that since 2010, buying short-term oversold weakness has been a very profitable endeavor.

% Stocks Above 10-Day S&P +5days S&P +10 S&P +20

0.17% 0.43% 0.70%
50%-75% 0.03% 0.23% 0.78%
25%-50% 0.23% 0.42% 0.52%
0%-25% 0.85% 1.27% 2.47%

One thing that gives us pause at the moment is that the S&P is nearing the upper region of this indicator.  At one point today, nearly 80% of stocks in the S&P were above their 10-day.  However, after the sell-off into the close the indicator settled back down at 57%.  Certainly not fool proof but this is a measurement that's served as a helpful cue in recent years.

-Ryan Worch

Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

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