Sunday, February 28, 2016

Week In Review (2/22 - 2/26) - Volatility Edition

Stocks posted their 2nd straight week of gains last week and the S&P 500 is now poised to finish February in positive territory after being down more than 6% at one point earlier in the month.

The powerful reversal could land February in rare company as only 8 months since 1970 have been down more than 6% and managed to ultimately finish in the green, this according to LPL.  Unfortunately, we're in a leap year so we've got one more trading day before we can record this month as a success.

With the gains made over the last two weeks, the S&P now sits down just 4.7% year-to-date.  However, the Nasdaq and Russell 2000 lag far behind with each being down more than 8% in 2016.

If you review the action of the VIX index over the last few months, you see that volatility has increased steadily over that time.  Using the VIX as your default measure is fine but we like to supplement such studies with other tools to gauge realized volatility.

One such tool we use is to measure how often the market makes large moves in any given month or timeframe.  For example, we track how often the S&P is up or down more than 1% in any given month.  We do the same for 2% moves.  The charts below tell an interesting story:

First, so far in 2016 we've had 23 days where the S&P has gained or lost more than 1%.  There were 13 in January and 10 so far in February.  While 2015 also featured two months where more than 10 days were up/down greater than 1%, they were not back-to-back.  And when we factor in that one of those months was December, we see that we've topped 10 days of 1% moves in the last three months.  This type of action and volatility is reminiscent of the stressful periods that we saw in 2009 (market bottoming after crisis), 2010 in the aftermath of the flash crash and 2011 during the European debt crisis.  In contrast to those years, 2012 and 2013 did not feature a single month with 10 or more 1% moves.  And in 2014, only October had 10 or more 1% moves.

So we've clearly stepped into a more volatile environment and when we look at the last few months relative to recent years it probably feels even more uncomfortable for some because of just how calm those markets were.  To take it one step further, January alone had 5 days where the S&P moved 2% or greater.  By contrast, 2013 only had four 2% days while 2012 and 2014 had just 6.

Another volatility measure we use, Average True Range (100 period) seen in the bottom panel, shows that we're nearing levels not seen since the 2009-2011 stress periods mentioned above.

Lastly, the ratio chart below of Gold (GLD) vs the S&P shows that some level of the fear trade has kicked in.  After 4 years of underperformance, GLD looks to have broken-out relative to the S&P and could be looking establish an uptrend of outperformance.

What's clear is that we've seen a ramp in volatility.

Have a good trading week!

Sunday, February 21, 2016

Week In Review (2/15 - 2/19)

After logging the 2nd and 3rd legs of a 3-day winning streak (where the S&P was up more than 1% on each day) on Tuesday and Wednesday, the market started to flash some short-term overbought measures and on cue the index stalled out on Thursday and Friday.

A few of those measures are shown below:

1) The % of stocks above their 10-day moving average is overbought; and the % above their 20-day is getting close

2) 5-day RSI is reaching overbought

3) One way we identify extreme overbought conditions is tracking the # of stocks up 50% in a month.  When that number goes above 20 it has generally served as a warning that the market has become overheated.  We hit that point on Thursday but what's interesting is how quickly this measure reached an extreme.  We ran a study looking at the bigger corrections since 2010, the bounces that followed and how quickly they reached overbought on this breadth measure.  The results are shown in the chart below and observations follow.

  • Once you get overbought after a bottom the returns going forward (5, 10, 20 and 50 days out) are muted.
  • The average number trading days before you get the first overbought signal is 55 days.  This last reading took just 4 days!
  • 4 days is BY FAR the fewest in this sample and we have no idea what it could mean.  One way of looking at it would be that this move is really powerful and the market is setting up for a further push higher.  But bears would probably argue that these are the market's last gasps and we're going to really roll over soon.
Taking a longer term perspective, the weekly TLT:SPY ratio chart shows the TLT bumping up against long-term resistance and on the verge of breaking out.  If this plays out it would suggest that equity markets are vulnerable to further underperformance.

Stocks turned in a big week on the back of the Tuesday-Wednesday surge.  At Friday's close, the S&P had gained 2.8% over the shortened trading week.  Year to date however the market remains firmly in the red with the S&P down 6%, the Nasdaq down 10% and the Russell 2000 off by 11%.

We'll see how the short-term overbought readings we mentioned get resolved in the coming days.  Hope you had a great weekend.

Monday, February 15, 2016

Approaching A Tradable Bottom?

As we prepare to kick off the holiday shortened trading week, one observation we're keeping squarely on our radar is shared below.  The charts below examine four different periods over the last 30 years and compare the price action of the S&P 500 with one of our favorite indicators.  What seems clear from the data is that we're either getting close to a tradable rally OR the market is on the verge of taking a nastier dive.  

The charts look at the following periods: current market, 2007-2008, 1998-2000, 1987-1990.  The price of the S&P 500 is shown in the top pane of each chart and the corresponding bottom panes show the percentage the index is above/below its 200-day moving average at the time.

A few things can be noted from these studies: 1) We've seen many instances over the past 30 years where once this indicator drops down to the -10% area it has represented an extreme and a place where the market has bounced.  2) There have also been periods where the -10% marker has served as little support when the market hit true moments of stress (2008, 1999-2000, etc).  There we saw both the index and this indicator drop to much lower levels and stay depressed for months.  3) Whatever the path that's taken, this indicator has a history of ultimately being fairly useful once it shows a positive divergence from price.  Once we see that "all clear" signal it may be a sign that the market has made its final lows in this pullback/correction/what-have-you... 

Current Market

2008 Bear

1998 and 2000 Bear

87 Crash and 1990 Bear

Even with Friday's powerful rally, stocks still finished in the red last week.  After trading below January's low of 1,812 on Thursday, the S&P rallied on Thursday afternoon and Friday to finish the week down less than 1%.

That being said, the index continues to suffer on a year to date basis as it's still off almost 9% from 2015's close.

In another sign of the market's current "risk-off" attitude, Utilities and Staples remain the clear sector leaders so far in 2016.

Futures look to be signaling a very green open for the market tomorrow.  We'll see if such a scenario has staying power this time.

Wednesday, February 10, 2016

Some Things We're Seeing Now...

We constantly track a variety of indicators to guide our biases over any number of timeframes.  We've carried a defensive near-term posture since the beginning of the year as many of the indicators we evaluate suggested that we might be operating in a bear market.

A primary characteristic of a bear market is that it will feature sharp rallies that are eventually sold into at lower highs while taking out prior lows.  In the market's most recent drawdown, the S&P made an intraday low on January 20th of 1,812, a level that has held so far.  However, in the last week, both the Nasdaq and Russell 2k have made new lows as prior tech leaders have seen aggressive selling.  We'll see if a break of 1,812 is in store here for the S&P over the next several days.  Today's strong reversal to the downside is suggestive of more weakness.

Some obervations of the current market.  Breadth is putting in a positive divergence as the markets have tested or broken prior lows.
  • New 52 week lows (NYSE) has dried up compared to the January 20th low
  • New monthly lows peaked in January (We track this across the whole market)
  •  The % of stocks above their 10, 20, 50, and 200 day moving averages are showing positive divergence

These divergences could lead to a short-term bounce at any point.  But until we see real selling panic, we continue to side with the idea that the lows are not in.  Below is a measure of the VIX term structure which compares the VIX to the VXV.  You can see from the chart that bottoms have coincided with spikes in this ratio.  The 2010 and 2011 bottoms saw panic in the form of a spiking VIX to the 3-month VXV.  What was also characteristic of those bottoms was that fear spiked well before price eventually bottomed.  And that may end up being the case with this market.

There also remains a consistent bid in flight-to-safety instruments.  As gold, silver, and bonds have seen a huge inflow of capital.

Bear markets are best known for consistently eroding investor capital.  In an effort to avoid falling victim to that trap, we're staying very defensive with our exposures and position sizing until there's a higher degree of confidence that the lows have been made.