How Unhealthy is the Stock Market in 2016?

After finishing the first full week of trading in 2016, there was nothing to be happy about the stock market. This was the worst start ever in the history of the stock market, and it all points to some more bad behavior on the horizon. With earnings season around the corner, there is nary a stock that is in position to make a move to higher ground. What seems to be ailing the markets that would have this market down so much? 

Bullish Percent

2016 is turning into the year of the black swans. Four of them hit this week (N Korea, China twice, Saudi/Iran conflict) and sent this message to the markets – be very aware. The Fed is far more hawkish than they have been since 2006, the last time they raised interest rates. What’s interesting, not many are aware of the implications of a shift in policy. Remember what Marty Zweig said so many years ago – ‘Don’t fight the Fed’. I don’t care if rates are near zero, a policy of rate hikes is NOT accommodating. They will spin this the other direction, but that is not the truth.

The Dow Industrials plunged 1000 points this week, falling 5.7% on very heavy turnover. This is a sign of institutional selling or distribution, where the ‘big boys’ are cutting stocks at a rampant pace. There is no discussion of what to do – when funds are selling you get out of the way. One may believe when the ‘baby gets thrown out with the bathwater’ therein lies opportunity to buy at lower prices, but I would suggest caution and patience at this point.  

Over half of all stocks are in a bear market, having fallen 20% or more. These stocks are in their own personal purgatory, and some sectors like energy/services have been bludgeoned. We don’t catch falling knives, there is no reason to try and be a hero. How many bottoms were called back in 2008 (many, believe me) until that final bottom was made? How much emotional, mental and real capital would have been saved by just being patient back then? Exercise that restraint now. 

Volatility is spiking, much like we saw in August. Option premium is swelling as the market is expecting big swings in both directions. Put/call ratios are elevated and that is normally a sign of real fear, but what is truly concerning are the breadth statistics. These have been weak since peaking in Jun 2014, so there has been literally eighteen months of heavy distribution – sometimes interrupted.

Currently the McClellan Oscillator is at extreme oversold levels, indicating a powerful snapback rally is due, and what we have been used to is a stretched rubberband snapped back so far that the market slingshots. I’m not sure there is enough interest this time around to buy a major dip, but that remains to be seen. As we mentioned with earnings season to come, it’s not smart to be short in front of it or during it, but we’ll have to see how the pace goes. Oversold market, that doesn’t mean it’s a buy. Trying to pick a bottom is a loser’s game.

Vix Term Structure


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