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.

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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