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This Bleak Tape Hides Short Term Opportunity at Trader’s Narrative





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Yesterday I wrote about a shift in the balance of power and how the market was barely holding on to the “box of bullishness”. That is to say, the technical underpinnings for a cyclical bull market. Today, with the 4% declines in equity averages, that was broken to the downside rather decisively.

The percentage of S&P 500 stocks trading above their 150 day moving average declined even more, falling 21.4% points today to reach 37%. The last time it was this low was in April 2009 as the cyclical bull market was just revving up.

The percentage of S&P 500 index stock trading above their 200 day moving average experienced a 16.6% point drop to 50.4%. That is a very large daily move and it goes to show that so many of the S&P 500 components were holding on for dear life to their long term trend. As they fell through the floor, the move wasn’t all that subtle today.

relative SPX compared to 200 MA May 2010

The S&P 500 index is now 2.72% below its long term trend. The last time it was trading here was at the end of May 2009. A far cry from the 21% above the long term average we saw back in October 2009. On that day the S&P 500 was at 1096.56 - about 25 points higher than today’s close.

Another technical indicator of the shift underway is the Nasdaq new 52 week high to low ratio. It is now back to mid-March 2009 levels:

nasdaq new 52 week high low ratio May 2010

While all of this points to a change in tone for the market which is far more bearish, we have to remind ourselves that the market doesn’t go down in a straight line. In fact, in the short term, we are approaching an area of opportunity for the bulls - if they are agile.

Moving Averages
To start, let’s return to the percentage of stocks above their moving averages. Earlier this month I shared a simple way to use the long term and short term in a ratio to find buy points. The key level to watch for this ratio is 0.5 since it corresponds to intermediate lows.

This ratio for the S&P 500 fell below 0.5 on May 6th and then again on May 14th. Right now it is at 0.16 - the lowest it has been since the tumultuous markets of October 2008. This is because the percentage of S&P 500 stocks trading above their 50 day moving average has plunged to merely 6% - a 3 standard deviation move below its medium term trend. The last time it was lower was early March 2009 (at 5%).

If I were forced to pick any single breadth measure for market timing, this would be it. Its track record for spotting important lows is impressive. To further stress the importance of this measure, and to show how pervasive the washout is, consider that for every major sector has less than 10% of its components trading above their 50 day moving average.

For some, there are just charred craters where there once stood whole sectors. The financial sector has just 1% of stocks above their 50 day moving average. Energy (thanks BP!) has zero.

Nearby Support
Applying basic support and resistance we find that the market is almost at an important support level. The S&P 500 found support after the February correction at 1060 - some 10 points from where it closed today. The next support level is also close at 1040 (from November’s low).

Extremely Negative Breadth
Breadth was extremely negative today. At the NYSE there were 2983 declining issues and only 160 advancing ones. The Nasdaq had slightly better breadth with 2524 declining issues and 221 advancers.

As well declining volume overruled advancing volume by a massive margin. For the NYSE, volume flowed into declining issues to advancing issues by 73:1. For the Nasdaq, it was slightly less worse at 43:1. Those numbers may be different depending on who which data provider you rely on. But at such an extreme point, the over all picture is clear.

Not surprisingly the Nasdaq McClellan Oscillator (Ratio Adjusted) is once again back to levels we hadn’t seen since October 2008. The message from breadth is that we have a rush to the exits with indiscriminate selling.

Fear Is Your Friend
Fear is the contrarian traders friend. We’re finally starting to see some real concern creep in. For example, the CBOE volatility index (VIX) is now at 46 - the highest it has been since March 2009.

Retail option traders, as measured by the ISE sentiment are finally worried enough to buy some puts (for once!). Today’s ISE sentiment index was 100, the lowest it has been since June 18th 2009 (92). But more important than the daily fluctuation, the 10 day moving average of the equity only ISE is now at 147.50 - slightly below where it was at the bottom of the February correction.

Finally we have an anecdotal sentiment gauge in the recent CNBC Fast Money roundtable where a contributor was apologetic for being bullish!

Famous Last Words
To recap, while I recognize the ominous signs that we are seeing a potential trend change and that this does not look like another regular correction within the cyclical bull market, I have to force myself to not succumb completely to the doom and gloom. Otherwise, I’d risk missing out on a short term opportunity for a bounce from an extremely bleak tape.

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13 Responses to “This Bleak Tape Hides Short Term Opportunity”  

  1. 1 Jimmy

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    I agreed we are due for at least a short term bounce. If it’s a bounce then it shouldn’t exceed last high (Nasdaq 2324 and SP500 1173.) I believe we made a momentum low but not a price low yet. Maybe one more new low in another week or so before a better rally will ensue.

  2. 2 PJ

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    I have been reading your blog and have found it useful and informative.

    I agree that a short term bounce and your reasoning is logical with all the data that you provide. We will see a short term bounce and it will be good if you are a trader.

    Thanks for all your timeless work and analysis.

  3. 3 MikeTaylor

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    I agree, but bear in mind the risk… See

  4. 4 thunderbird

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    I don’t get how today can be compared to Oct 2008-Mar 2009. Then, you had all sorts of US banks going bankrupt, along with the destruction of the US housing market. But what’s the imminent danger now? Uh, Europe running deficits? Ooh, scary! Greece defaulting? Who’d notice? Wasn’t peripheral Europe a basket case for years anyway? Did we just figure this out now?

    Perhaps you can pin the whole thing on a carry-trade unwind. That’s an intriguing explanation. But otherwise I see no reason for an *immediate* collapse. I see no wealth being instantly annihilated like last winter.

    A world-spanning Japanese malaise could be in the cards for the next 20 years, maybe, but that would be a slow downfall, not this.

    Either there’s a monster in the closet like a major carry-trade movement, or maybe this whole thing is just the international banker cabal worrying that the Europeans will start hanging their corpses from lamp-posts. I think the latter would be good for the economy, though, so even that can’t be it.

    I don’t get it. It’s gotta just be that >10% correction we were all waiting for.

  5. 5 thunderbird

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    PS, today might be an outside day to the upside, from how it looks right now.

  6. 6 Avi

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    The stock market looks oversold but its not helping that LIBOR OiS spreads keep blowing out indicating stress in the banking sector, and fixed income is trading at the top of the range, indicating possible deflation. …2 year yield in Germany is .5% and US its .7%… until they go back up, we have stress in the market

  7. 7 Rod

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    Mixed breadth picture today: More Advancers than Decliners, but it wasn’t enough to improve Net New Highs. In fact, despite the rebound today, the Nasdaq had 9 New Highs vs 129 New Lows

  8. 8 Rod

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    Avi,

    x 2.

    In times of stress, the fixed income market will lead.

  9. 9 OntheMoney

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    thunderbird,

    It’s interesting that some US traders still don’t get the danger. Until the EU came up with that $1trillion bailout we were heading inexorably for meltdown 2.0. It may still happen.

    It’s not JUST that much of Europe - including big export markets for the US and China like Spain and the UK - are set to drop back into recession because of their self-imposed austerity measures…

    It’s not JUST that banks all over the Eurozone are carrying trillions in euro debt from the PIGS (German banks have half-a-trillion in PIGS debt alone) some of which is CERTAIN to be written down/restructured…

    It’s not JUST that Brazil has fallen into a bear market and the other emerging countries are heading that way (see EEM double top) -

    It’s not JUST that China has the mother of all real estate bubbles which, should it burst (and the smartest money says it will), would poleaxe emerging and commodity-producing nations and send oil/steel/copper etc. into freefall -

    It’s not just that the carry trade would spectacularly unwind from such a freefall -

    It’s not only these little worries that have bitten the market’s backside, thunderbird, it’s that all of them lead, in some way or other, from the banks of all the affected countries straight back to the door of JPM, C, MS, and BAC…

    It’s unlikely this will hit yet and we do look set to bounce here. But don’t fool yourself that we’re on the road back to business as usual. This time really is different.

  10. 10 thunderbird

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    As for China, y’know, the Economist did point out that housing there now is cheaper than it was a few years ago, relative to individual incomes. There certainly is a bubble in the extreme high-end, in the luxury housing, and I bet China won’t mind seeing that get wiped out. But the breadth of the Chinese housing bubble is a fraction of that for the US bubble.

    China’s equities have been horribly overvalued relative to the maturity level of its market, anyway. It’s about time their stocks go down! The bubble is deflating there, not bursting. And the same is happening in Brazil - yet more foreign investor overzealousness was driving their market higher than it should have been for a developing country.

    Is this the first time you’ve seen a favourite sector get kicked back down the following year? Face it, if you’ve stayed in a high-risk sector for more than 6 months, you’re going to see it collapse.

    Besides, I look at HAO and CQQQ and see nothing but a higher-beta downturn relative to US. They’re still tracking fine. China isn’t going to die anytime soon.

    I appreciate there being a large number of problems happening all at once. I just don’t see them having been made salient, the way Lehman made the US’ disaster salient. Big brooding disasters like US real estate take 1-3 years to happen - people were warning about US bank lending in 2006.

    And as for peripheral Europe, I really don’t understand what’s new here. But a collapse in the Euro value, maybe to par with USD, will be just the thing to drive fantastic export growth.

    I don’t see where the capital is being destroyed this time. In 2008 you could point to destroyed capital on every street. Now? Where is it now? Someone’s balance sheet? Pfft.

  11. 11 Wes

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    Just an excellent and timely summary. Thanks, Babak.

  12. 12 OntheMoney

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    thunderbird,

    you’re right, this isn’t Oct 2008, this is August 2007. The problems are salient only if you’ve been long and you’d rather not wait ’til an ‘Oct 08 moment’ to realize you were complacent. It’s salient if you’re short by pointing you towards some historic opportunities.

    All this is unlikely to play out in the same way as subprime if only because most investors are now attuned to the dangers and history only rhymes. But macro fundamentals are stacked against the bulls here.

    Also, as Matthew Classen recently pointed out in this blog (http://www.tradersnarrative.com/thoughts-on-the-primary-trend-matthew-claassen-4020.html) traditionally bullish indicators can become your enemy when you’re trying to apply them in a secular bear market environment. And I’m a great admirer of Wayne Whaley’s bullish technical posts here, but they risk embarrasment should bitter secular winds start to blow.

    Incidentally, China doesn’t just have a bubble in a few condo developments. It’s pervasive throughout commercial and residential construction. Chanos (http://www.charlierose.com/view/interview/10960), Soros (http://www.businessweek.com/news/2010-04-09/soros-says-china-bubble-bursting-could-reverberate-globally.html) and Xie (http://www.businessweek.com/news/2010-04-25/i-ll-tell-you-when-chinese-bubble-is-about-to-burst-andy-xie.html) have independently come to the conclusion that it’s a serious situation. Individually, these guys are rarely wrong on such a major call. If you want to bet all three are wrong this time… go right ahead, buy the dip.

  13. 13 MachineGhost

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    thunderbird, you’re also overlooking the fact that stocks worldwide are still overpriced, most specifically in the U.S.. Values have to decline to be able to deliver the long term returns everyone has become spoiled to expect (of course that will happen only after they all give up in disgust, but I digress).

    In the 1920’s, sovereign debt bonds of European countries imploded one by one as capital fleed to “safer” countries only in turn to repeat the same process all over again. The end result was trade wars culminating in the Great Depression. You don’t think thats a concern?

    You may not understand how monetary and fiscal policy really works, otherwise you wouldn’t be so glib about carrying bad debt on a balance sheet. To the extent any government monetizes such debt so other sovereigns and bank bondholders don’t take a haircut, it takes capital away from the free market. That destroys capital, which destroys innovation, which destroys businesses, which destroys jobs, which destroys earned income, which destroys tax revenues and ultimately, destroys living standards. That is what Japan, the U.S. and now Europe is doing.

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