These are unprecedented times in the financial markets, with wealth destruction being seen across virtually all asset classes both domestically and abroad. This month in our regular bulletin our newly joined analyst Tarquin Coe takes a look at what we can learn from the picture in the option, bond and overseas equity markets whilst colleague Mike Burke, veteran of many bear (and bull) markets casts his mind back to the ’87 and ’73 bear markets.
For those of you who have yet to subscribe to Investors Intelligence, we are throwing in a special offer this month….. Sign up now to receive our US Stocks Service and get a one month trial to our ETF Review Service, FREE! Just click here to register!
Finally, a quote from the great Warren Buffet to ponder on; “The time to be greedy is when others are fearful. The time to be fearful is when others are greedy”. For sure, the markets are fearful at present, but capitulation may be close at hand. Certainly, we will monitoring the markets closely over the next few weeks for further developments in our Buy/Sell Climaxes and Advisors Sentiment Indicators (see below) and we will be keeping our subscribers closely in touch with the results.
John Gray, Senior Editor, Investors Intelligence
The CBOE Volatility Index (VIX)
The CBOE Volatility Index (VIX) is a fear gauge, a barometer of market sentiment. Readings above 30 reflect high volatility resulting from uncertainty. The end of September saw the gauge stretch to 48.4, the word “stretch” is fitting, as like elastic, it has the tendency to spring back. The index has an inverse relationship to the market and current readings on the indicator were last seen in 1998 (Russian debt crisis) and the bear market bottom in 2002/3. With extreme fear now priced in, investors should be ready for an imminent fight back by the equity markets.
Equity markets had a rough ride during September, historically one of the weaker months of the year.
In the US, the S&P smashed through the July lows on the 15 of September, before hitting its lowest level since late 2004 three days later. That break was reversed intraday as rumors of a ban on short-selling and Fed rescue package started to surface. US indices performed an intraday “V” reversal that day on the highest volume for a number of years, and with bullish breadth the outlook was decidedly positive going forward. Last issue we said a break of the July lows would be no bad thing, as it would shake out weaker positions. That proved to be the case, with a colossal number of selling climaxes, surpassed only be the January and July lows. The buy/sell climaxes chart now shows a bullish divergence, implying that selling pressure is alleviating as the market makes new lows. This selling climax data at the mid-September low is a buy signal, and the current breach is likely to be reversed during October.
Sectors in the US market are now deeply oversold, as is clear from the Industry bell curve below, with the bulk of sectors now in the 10% category. This category means that less than 10% of total stocks in a sector are showing P&F buy signals. The January lows saw even more severe oversold conditions, with 27 groups appearing in the 10% category, compared to 23 currently. Whether this is a bullish divergence, or things need to get worse before they get better, should become clearer over the next four weeks.
Blue indicates Bull status, Red indicates Bear status. Groups marked with a + are in an up column. Groups marked with a – are in a down column.
Updated through Sep 29, 2008 Click on a box to see the chart. Hover over a box for more details.
In Europe, there have also been violations of the July lows. The FTSE 100 (UKX) and Euro STOXX 50 (SX5E) are testing the mid-September lows into the end of the month.However, like the US indices, sharp capitulation like declines are often retraced with equally aggressive rallies.
Ahead of the open, on each trading day, we provide subscribers with informative analysis of market action and likely direction in our Daily Hotlines, with separate reports for the US and the UK. The US Hotline is written by John Gray and Mike Burke and theUK Hotline is edited by Dr Jackson Wong.
Advisors Sentiment Survey
Our Advisors Sentiment Survey, running for over forty years, maintains a long-term bullish reading, having recently shown the same level of bearishness as the 1994/5 bottom. Over the short-term, we are seeing an increase in bears and drop in the bulls, causing the bull-bear difference chart to edge lower. Historically a reading of -20 has provided support, so we are likely now experiencing a drift down to, and then test of, -20. A visit to that level would be positive and imply a bottom for the medium-term was at hand.
The survey is compiled by Mike Burke, a stock market veteran of fifty years. Here is Mike Burke’s view following the deterioration into the end of September.
“Monday’s 777 point drop in the Dow Jones Average was its biggest point loss in history. Our philosophy has always been that wherever the market is going on the downside, the quicker it gets there, the better it is. Big drops like Monday’s are caused by panic on bad news and often result in selling climaxes and people wanting to get out no matter what the price. The failure of congress to take any kind of action made the current seem hopeless. A couple of hundred points of the drop came in the last few minutes just before the market close. Action was kind of similar to what was seen in 1987 when the Dow had a 20%+ fall, still the biggest one day % drop of all time. Since the definition of a bear market is a loss of 20% in the Dow, that was kind of a bear market in one day.
In contrast, the 1973-1974 bear market was a slow, painful experience. From its high to its low the Dow was down 45%, but the broader based Value Line Index lost 75% from top to bottom. During this terrible period, the market did not have any big drops. It just went slowly and persistently and it was like having blood drained from you one drop at a time. Price Earnings ratios, after getting down to an historical low of about ten times, fell to nine and then to eight and then to seven and then to six and then to five. You could not find a stock selling at over ten times earnings.
In spite of the cheapness of stocks, people just did not want them. There was never any real bad news or any panic, stocks just went down. We eventually went from the very high P/E’s of the late 1960’s to the once in a lifetime bargains found at the end of 1974.
Wherever we are going now, the faster we get there the better it will be. “
Action in the Commodity markets has taken a back seat as news from the Financials has dominated the headlines.
Crude oil traded a twenty dollar range through September and last month we noted the presence of the 200-day moving average. This average was breached at the start of the month but the price has since rallied back to its underside. We may now get continued sideways trading between $90 and $110 for a few more months yet. A similar 20% range was seen in 2006, with a break of the average in the first week of September, followed by sideways trading below the average until late March 2007, a basing process that took just over six months. Long-term the trend for Oil is still up.
Fears over a financial meltdown and weakness in the USD have both contributed to renewed interest in Gold.Traditionally seen as a safe haven, Gold outperformed the S&P500 by as much as 25% during September. The long-term trend in Gold is up and we would not be surprised to see another dig at $1000 in the months ahead.
Commodities are covered in the Daily Commodity Hotline, which analyses the key US and European contracts. Analysis is by Cornelia Dichio, who started her career with David Fuller of www.fullermoney.com, she has over 20 years of experience as a Technical Analyst.
Fixed Income Hotline
Our Fixed Income Hotline, like our other dailies, runs a long/short model portfolio, a daily email update and provides access to an extensive library of online charts, tools and indicators.
Analysis is written by Jackson Wong and below is his ‘chart of the day’, taken from the last week of September.
“The spread between the 10-year US bond yield and 3-month Treasury yield often gives us an indication of the shape of the yield curve.
At the moment, the yield curve is very steep. Their difference has soared to 300bps lately. Judging from the brisk pace of increase, the spread could reach as high at 360-380bps soon.
Historically, when the spread is as wide as this, it indicates a weak economy, possibly recessionary. For example, the last two times the spread rose to these levels coincided with recessions in the US.
Therefore, according to this spread, it is likely that the US economy may have slid into a recession already. Extrapolating this view means that the US Fed is likely to remain in a dovish mode in the foreseeable future.“
In the realm of Currencies, in last month’s issue we discussed the Greenback’s rally. We expected a continuation of the rally as far as 80 on the Dollar Index chart (DXY). That level proved to be a ceiling, as expected, and the index has since dropped back.Price action is now hovering at the 50-day moving average and an eventual break back below this average is expected eventually, given the strength of resistance at 80. As we noted last month, the significance of 80 becomes apparent on the quarterly chart, where it provided stern support for 18 years before giving way last year.That level is now resistance and is likely to prove formidable.
Currencies are covered in the daily FX Hotline, which covers key technical movements and developments across global currencies. Analysis is by Cornelia Dichio.
At the end of each week we publish an ETF Review, a report that analyses chart movements amongst the ETFs and highlights trading opportunities. Into the end of September we suggested buying international ETFs, taking advantage of recent weakness. The risk reward at current levels is excellent and we suggested using a sustained drop below the recent lows as a stop. We say sustained, as bear traps are more likely in the current climate, so investors should not let volatile swings take them out of good positions.
In particular we liked the ETFs for Canada and Australia (EWC and EWA), as they are starting to show outperformance. These countries have a good resource presence in their indexes, so rising Gold will benefit these international ETF’s.
We cover all areas in the ETF arena: International, sectors, commodities, currencies and fixed income. Amongst the sectors during September, we liked the Pharmaceutical HOLDRs (PPH) as it tests horizontal support and stages market outperformance.
The ETF Review is now analyzed and written by Tarquin Coe. Subscribers to the service also get invaluable access to our extensive chart library and range of charting tools.