There is a very yummy Italian dessert called brutti ma buoni, which literally means: ugly but good. That is what I think of when I ponder today’s market action. Ugh, really ugly… but at the same time, good. Good in the sense that things could be setting up for one of those, one-in-a-while rare opportunities. Let’s take a look at the market entrails and see if we can gain some insight:
If anything is a testament to the ugliness of what happened, it is the breadth numbers (above). I’m too lazy to calculate it but I’m pretty sure this was one of those Lowry’s 90/90 days. What we now have to watch for is the inverse - a 90/90 up day.
Taking a look at the % above MA numbers, most are very close to reaching extreme oversold levels. But they aren’t there fully. Yet. For example, the % of stocks above 50 MA for the NDX is at 27 while really oversold levels that were reached before were between 20 and 25.
And today, the ratio of TSX % above 50MA and 200MA - which I mentioned just yesterday - reached 0.39. At this level it is seriously oversold and is just begging for a snap back rally.
There is no question that sentiment is quite lopsided towards pessimism and fear. The past few day’s market action will be reflected in the surveys coming outnext week. But right now you can see it reflected in the Rydex Nova/Ursa ratio:
As you can see from the chart above, the Rydex crowd hates the long side a tad bit more now than they did in October of last year.
Another measure of sentiment, the CBOE Total Put/Call ratio is in the stratosphere! It reached 1.52 - a decade high. It has gone now for four straight days with more puts traded than calls. It’s almost impossible for this metric to get more lopsided.
A final measure of sentiment: there was a stampede into ETFs and out of stocks. This is a significant tell since when traders are spooked, they seek the liquid haven of ETFs and foresake the less liquid individual stocks.
A whole host of internal metrics are showing very oversold levels. Take a look at the McClellan Oscillator for the Nasdaq:
And the ratio of new highs to new lows on the NYSE is also startling:
As well as the Nasdaq Advance/Decline Issues :
Looking at the volatility measures (VIX, VXO and VXN) we see that they have for the most part spiked higher to levels which in the immediate past have presaged market reversals to the upside. Some make the mistake of looking at the absolute value of the VIX (and other volatility indices) and thinking that they aren’t high enough since in the past, they have reached as high as 80. This sort of thinking is flawed because the absolute number isn’t as important as the relative number. What you should look at is a measure that would normalize the current reading. One way to do this is to compare the current daily reading to its 50 day or 40 day MA. If we do this, we find that relative volatilty indices are extremely stretched - even more so than their absolute cousins - and they are telling us that we are probably very close to an inflection point.
Here’s another statistic that will blow your mind: out of all the thousands of stocks out there, less than a third have managed to close up for the day in the past five consecutive days. This has happened at market bottoms like Sept 2001, October 2002 and May 2004. But before you get excited, this sort of pattern also has a history of presaging market drops (like 1987).
My conclusion? I thought you’d never ask. If you had short exposure, (congratulations! but…) this is the time to think about exit targets and adjusting your stops lower. It is not the time to be pressing shorts or initiating new short positions. We may have another whoosh down but the probability now points more to a rally. I would be searching here for potential long setups. I think we’re going to have so many soon that it’ll make you dizzy to choose from amongst them.
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