Thursday, January 14, 2016
We find predictions to be rather useless because quite truthfully no one knows where the market is going next. If you see someone on Twitter or CNBC pounding their chests that their latest prediction did indeed play out, it's more than likely they've got many, many more wrong-calls that they'd love to forget about. We prefer to deal with scenarios and probabilities and at the end of the day we let the price action guide us.
The trader's prayer is very applicable, "Dear Lord, grant me with the serenity to follow the will of the markets and not my own." (Hat tip to the great Art Holly!)
We track around 70 markets across the globe that span all asset classes. Currently close to 40% of those markets are in a bear market which we define as being down more than 20% from highs. Leading the carnage is the commodity space and commodity producing and export driven economies. Outside of those somewhat obvious areas there is plenty of weakness in biotechs, retail, and homebuilders as well. The strongest areas remain to be defensive sectors and flight to safety instruments. When you add this all together you find a global market environment that remains stressed. The major question facing investors and traders alike is whether this is a correction in a continued bull phase or something bigger.
For now this market remains oversold on various measures that we track while the VIX is elevated. Below is a list of indicators that are flashing oversold readings on the S&P 500.
% of stocks above 10, 20, 50, 200 day moving averages
New Highs - New Lows
There's more but basically this market is oversold anyway you look at it. What worries us the most is that in these conditions you are ripe for a huge short covering, oversold bounce like we have had so many times during the past corrections. But so far in this pullback, any bounce attempt has been feeble and suggests more downside selling is necessary to flush out the dip buyers. If the market changes from bullish to bear trend you can expect oversold rallies to be short lived and immediately sold into. That is classic bear market behavior. The data also tells us that the biggest rallies happen in bear markets so you have to be prepared for those if you plan to play the short side of this market.
Some other studies that we track that highlight the current market enviroment is correlations. We'll run sector-to-sector correlations and historical monthly correlations of sectors relative to the S&P. In a one-way down market everything becomes highly correlated. As of today we are not at extremes in any correlation measure versus the August bottom. Another potential tip that more selling is needed.
It remains a volatile environment and certainly one that is dangerous on the long side. We believe this is a market to keep some powder dry. If we eventually get a correction that meets the definition of a bear in the S&P 500 the good news is that it will give some absolutely great opportunities on the long side. Best to avoid the prediction game and maintain the serenity that the trader's prayer asks for.
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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