Though we had four down sessions this past week and drop of 2% for the SPX 500, the action had a more normal feel to it. What am I talking about? First and foremost, it was nice for a change the market sentiment was not being driven by Greece. Since mid-June that has been the case, the unpredictability over a resolution has gripped investors/traders in a panic. When payment deadlines for Greece passed it was all but assumed the worst would happen and volatility shot through the roof in a short period of time.
And then there is China, with their very sudden bear market (20% down or more) and their government’s attempt to arrest the selling. Their policy methods intervention, coercion and force are unconventional at best but seemed to work in the meantime. Their issues are complicated and far from resolved.
Finally, we saw the markets reacting to ‘normal’ stuff – the economy, worries about interest rates, fed policy changes, demand/supply for commodities and currency concerns. Not that these are easy issues to resolve, but when you’re not listening to political rhetoric from a nearly bankrupt country it makes the analysis less complicated.
But this past week had earnings season back on the radar, and given the lousy growth in the economy we were due to see some mixed results. So far this has been a case of the ‘haves vs the have nots’, but that has been a theme for the last few quarters. Commodity names are struggling, first seen by the results of Alcoa, which reported mixed earnings, weak guidance and the stock has dropped about 10% since.
As for the indicators, we had been warning a potential drop was due, and that happened. The SPX 500 fell 2%, the Dow Industrials off 2.77% and the Russell 2K down even more, off 3.12%. What did we see last week that foresaw a drop? The market was overbought on several measure and some pressure needed to be relieved, but these steep drops tend to get everyone overly concerned. While the drop was sharp we are not seeing encouraging signs the market may now turn HIGHER.
Let’s start with the VIX, it reached under 12% again last week, which has often been a danger sign. It doesn’t mean stocks cannot move higher, but that level has been marked as a point where markets lose altitude – if just temporarily. On cue, Tuesday started the decline and market could not recover the rest of the week. The VIX climbed but ‘only’ made it back to 13.74%. Further, the spot VIX separated from the futures on Wednesday when the July future expired, and that needed to be corrected. See the chart here from Jay Wolberg of www.tradingvolatility.net.
The skew index, which measures tail risk option trades (looking for big moves down) started to get jumpy, and when this rises to certain levels it tends to portray a move down is coming. This article explains more about the skew index. We can see by this measure the move up toward 130 on skew was a time to lighten the load, and sure enough this was a good predictor. The skew index is here.
The McClellan Oscillators were at elevated levels last week, the NYMOT flashed a reading of 150. We have often seen this zone to be a warning sign as well, as markets were way overheated.
Commodities have taken a big whack, gold and oil being the main desire of sellers’ satisfaction. Other commodities have also been clipped as it appears global demand is easing while supplies (especially crude) continues to rise. The dollar remains strong while other world currencies continue to falter. This may have ramifications down the road, but a strong dollar is good for the US economy.
So, for the coming week we now have an oversold market, the VIX higher but not outrageously high, put/call ratios elevated (showing greater fear), the McClellan Oscillators now very negative (nearly extreme), the skew index lower and the fear/greed index at the extreme fear level. Much like after the July 4th holiday when the indices breached the 200 ma markets may be ready to reverse gears, as sentiment is bearish enough that a contrarian move is highly probable.