Historic shift in volatility from small to large caps
There has been an abundance of discussion recently regarding the relative performance of large caps to that of small caps. Specifically, speculation has focused on the significance of the large cap outperformance for most of the past 6 months, as well as the small cap outperformance in just the past week. The dichotomy between the two groups, and its 180 degree shift last week, is perhaps best illustrated by today’s Chart Of The Day.
It shows the ratio between the S&P 500 Volatility Index (VIX) and the Russell 2000 Small Cap Volatility Index (RVX). As recently as July, the ratio sat at almost 8-year lows — not surprising considering both the record low volatility rally in the large caps this year and the struggles in the Russell 2000 since early in the year. Things can change quickly in this market, however. Last Wednesday, the VIX/RVX ratio spiked to a 6-year high. Furthermore, the reading was the 2nd highest on record, just behind October 22, 2008.
So what is the significance of this? For one, it illustrates the shifting risk focus from small caps to large caps. For those arguing that the small cap underperformance was a warning sign and would eventually be resolved by the large caps “catching down” to the small caps, this has been at least temporary validation. The spike in this ratio, and the reluctance of the small caps to sell off last week, was also likely a sign that the small cap selling had run its course, at least in the short-term.
Besides telling us what is happening, does the shift in this ratio give us any clues as to what is to come? Looking historically, we identified 4 other times since the origin of the RVX data (2006) when we saw a similar turnaround. None of the precedents were as extreme as the current example so we relaxed the parameters a bit. What we looked for were times when the VIX/RVX rapidly went from a 10-month low to a 10-month high (we chose 10 months because the obvious turn higher in 2007 came before we had 12 months of data on record and we wanted to include it). The 4 precedents came in February 2007, January 2010, March 2011 and August 2012.
A couple general takeaways from these prior events may be instructive to our present situation. First, besides the 2012 event, the others occurred into short-term weakness. Like our current case, large cap weakness was in some ways “catching down” to the lagging smaller cap area. The result, in those 3 instances, was a fairly significant bounce in the short to intermediate- term. That is the good news. The bad news is that all 4 of the precedents eventually led to a significant intermediate-term sell off. Those events included the flash crash, the 2011 bear market, the fall 2012 decline and, of course, the 2007 top.
We don’t like to read too much into one indicator, and especially not an event with just 4 precedents. Furthermore, the current markets — and markets in general — do not lend themselves to the notion of certainty. However, if there is any guidance suggested by the development in the VIX/RVX ratio, it would likely be this: markets may be near a short-term low; however, a dramatic shift in its risk profile has occurred and stocks are likely at risk of a more serious, longer-term correction after a bounce materializes.
At a minimum, some seismic shift has occurred in this market as demonstrated by the historic shift in the ratio, even if we do not yet know what it is.
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Historic shift in volatility from small to large caps

There has been an abundance of discussion recently regarding the relative performance of large caps to that of small caps. Specifically, speculation has focused on the significance of the large cap outperformance for most of the past 6 months, as well as the small cap outperformance in just the past week. The dichotomy between the two groups, and its 180 degree shift last week, is perhaps best illustrated by today’s Chart Of The Day.

It shows the ratio between the S&P 500 Volatility Index (VIX) and the Russell 2000 Small Cap Volatility Index (RVX). As recently as July, the ratio sat at almost 8-year lows — not surprising considering both the record low volatility rally in the large caps this year and the struggles in the Russell 2000 since early in the year. Things can change quickly in this market, however. Last Wednesday, the VIX/RVX ratio spiked to a 6-year high. Furthermore, the reading was the 2nd highest on record, just behind October 22, 2008.

So what is the significance of this? For one, it illustrates the shifting risk focus from small caps to large caps. For those arguing that the small cap underperformance was a warning sign and would eventually be resolved by the large caps “catching down” to the small caps, this has been at least temporary validation. The spike in this ratio, and the reluctance of the small caps to sell off last week, was also likely a sign that the small cap selling had run its course, at least in the short-term.

Besides telling us what is happening, does the shift in this ratio give us any clues as to what is to come? Looking historically, we identified 4 other times since the origin of the RVX data (2006) when we saw a similar turnaround. None of the precedents were as extreme as the current example so we relaxed the parameters a bit. What we looked for were times when the VIX/RVX rapidly went from a 10-month low to a 10-month high (we chose 10 months because the obvious turn higher in 2007 came before we had 12 months of data on record and we wanted to include it). The 4 precedents came in February 2007, January 2010, March 2011 and August 2012.

A couple general takeaways from these prior events may be instructive to our present situation. First, besides the 2012 event, the others occurred into short-term weakness. Like our current case, large cap weakness was in some ways “catching down” to the lagging smaller cap area. The result, in those 3 instances, was a fairly significant bounce in the short to intermediate- term. That is the good news. The bad news is that all 4 of the precedents eventually led to a significant intermediate-term sell off. Those events included the flash crash, the 2011 bear market, the fall 2012 decline and, of course, the 2007 top.

We don’t like to read too much into one indicator, and especially not an event with just 4 precedents. Furthermore, the current markets — and markets in general — do not lend themselves to the notion of certainty. However, if there is any guidance suggested by the development in the VIX/RVX ratio, it would likely be this: markets may be near a short-term low; however, a dramatic shift in its risk profile has occurred and stocks are likely at risk of a more serious, longer-term correction after a bounce materializes.

At a minimum, some seismic shift has occurred in this market as demonstrated by the historic shift in the ratio, even if we do not yet know what it is.

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International Stocks Testing Major Support
On October 6, our Chart Of The Day noted the 52-week low in the MSCI EAFE Index (Europe, Australia and Far East). Probably the most widely followed international index, the stealth new low in the EAFE caught many folks off guard. While Hong Kong and core Europe’s declines were just starting to get noticed, less obvious but more devastating declines in Australia and within the PIIGS and Latin America (not included in the index) were causing major negative waves throughout the global equity landscape. The new low in the widely followed EAFE was a wake-up call that something more serious was underway than the minor pullbacks of the past few years.
We ended the post with a mix of good news and bad news:

The good news is that significant support lies around 1740, signifying Fibonacci Retracement support from the lows in 2009, 2012 and June 2013. The bad news is everything else that we mentioned above. Additionally, if the upward momentum in the U.S. finally succumbs to a similar halting, more pressure could be heaped upon the international markets.
At a minimum, a 52-week low in the MSCI EAFE is a concerning development for worldwide equity markets — especially when investors actually notice it.

Well, as we know now, the U.S. markets did succumb to weakness and folks did take notice of the international markets hitting new lows and the global selling pressure intensified. In just 8 days since that October 6 post, the EAFE dropped another 16% (at yesterday’s intraday low). The good news is that the index has reached, and in fact slightly exceeded, the Fibonacci support levels we mentioned around the 1740 level.
The EAFE closed yesterday at 1715, under the support level we laid out. However, as we have mentioned several times recently, during a waterfall type of decline, prices can overshoot support levels, even the most significant ones. And this is one level we would deem significant.
We have mentioned Fibonacci Retracement levels many times. In our view, the best support (or resistance) comes when multiple Fibonacci levels, stemming from different major inflection points, line up together, for example, the 61.8% and 38.2% retracement levels. In our view, these are the two most significant levels and when they line up together, they offer very strong support. And even stronger support comes when the third most important level, 23.6%, lines up as well. That is what is in play now with the EAFE.
Specifically, here are the three Fibonacci Retracement support levels:
23.6% Fibonacci Retracement of 2009-2014 Rally ~1740
38.2% Fibonacci Retracement of 2012-2014 Rally ~1732
61.8% Fibonacci Retracement of post-June 2013 Rally ~1748
We are not fans of trying to catch falling knives. However, when we do, it is only into significant support. The MSCI EAFE is testing the strongest possible cluster of Fibonacci Retracement support. If it can reclaim the 1740ish level, it could set the index up for a significant rally, at least in the intermediate-term.
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International Stocks Testing Major Support

On October 6, our Chart Of The Day noted the 52-week low in the MSCI EAFE Index (Europe, Australia and Far East). Probably the most widely followed international index, the stealth new low in the EAFE caught many folks off guard. While Hong Kong and core Europe’s declines were just starting to get noticed, less obvious but more devastating declines in Australia and within the PIIGS and Latin America (not included in the index) were causing major negative waves throughout the global equity landscape. The new low in the widely followed EAFE was a wake-up call that something more serious was underway than the minor pullbacks of the past few years.

We ended the post with a mix of good news and bad news:

The good news is that significant support lies around 1740, signifying Fibonacci Retracement support from the lows in 2009, 2012 and June 2013. The bad news is everything else that we mentioned above. Additionally, if the upward momentum in the U.S. finally succumbs to a similar halting, more pressure could be heaped upon the international markets.

At a minimum, a 52-week low in the MSCI EAFE is a concerning development for worldwide equity markets — especially when investors actually notice it.

Well, as we know now, the U.S. markets did succumb to weakness and folks did take notice of the international markets hitting new lows and the global selling pressure intensified. In just 8 days since that October 6 post, the EAFE dropped another 16% (at yesterday’s intraday low). The good news is that the index has reached, and in fact slightly exceeded, the Fibonacci support levels we mentioned around the 1740 level.

The EAFE closed yesterday at 1715, under the support level we laid out. However, as we have mentioned several times recently, during a waterfall type of decline, prices can overshoot support levels, even the most significant ones. And this is one level we would deem significant.

We have mentioned Fibonacci Retracement levels many times. In our view, the best support (or resistance) comes when multiple Fibonacci levels, stemming from different major inflection points, line up together, for example, the 61.8% and 38.2% retracement levels. In our view, these are the two most significant levels and when they line up together, they offer very strong support. And even stronger support comes when the third most important level, 23.6%, lines up as well. That is what is in play now with the EAFE.

Specifically, here are the three Fibonacci Retracement support levels:

  • 23.6% Fibonacci Retracement of 2009-2014 Rally ~1740
  • 38.2% Fibonacci Retracement of 2012-2014 Rally ~1732
  • 61.8% Fibonacci Retracement of post-June 2013 Rally ~1748

We are not fans of trying to catch falling knives. However, when we do, it is only into significant support. The MSCI EAFE is testing the strongest possible cluster of Fibonacci Retracement support. If it can reclaim the 1740ish level, it could set the index up for a significant rally, at least in the intermediate-term.

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Record spike in Inverse ETF Volume one sign of a bottom
Over the past 2 years, one of our favorite indicators of stock market sentiment has been the volume in inverse ETF’s. As we have discussed several times, we like to look at the relative ratio of volume in inverse ETF’s (funds that go up when the market goes down and vice-versa) to the total volume on the NYSE and Nasdaq. This indicator can give us an idea of how complacent (when the ratio is low) or fearful (when the ratio is high) traders are on a real money, real time basis.
One word of caution is that, due to the relative newness of the ETF’s, we do not have a lot of history on them or, by extension, the relative volume indicator. Therefore, we cannot be totally confident in how the indicator will behave, nor the levels that should be considered significant.
That said, we do have roughly 5 years of solid data and volume in these issues. Therefore, they can be, and have been, of vaue. Over the past few years, whenever relative inverse ETF volume has risen above roughly 1.5% of exchange volume, the stock market has tended to put in a short-term low either immediately or within days. On Wednesday, the ratio hit an all-time record of 2.5%. Now, the current decline is obviously a more serious event than any of the previous declines since the fall of 2012. Therefore, we would expect that relative inverse ETF volume might exceed recent spike levels. However, exceeding the 1.5% level by such a wide margin is certainly compelling evidence for it satisfying a bottom to the recent decline — at least, part of a bottoming process.
The previous record high in relative inverse ETF volume came on October 4, 2011 — the exact low date of the worst correction in the past 5 years. That high was 2.05%. So based on a comparison with the previous record, the recent reading again appears more than sufficient to satisfy an end or ending to the decline.
We say “ending” because, considering the nature of the current decline, we have strong suspicions that a bottom to it will unfold in a more traditional manner than the plethora of V-bottoms over the past two years. This decline has been more serious and we suspect that a V-bottom and subsequent moonshot back to the highs is not in the cards. A bottom here will quite likely include some kind of a retest of this week’s low before it is off to the races again. Therefore, this may just be the initial spike in inverse ETF volume. In the 2011 sell off, we saw inverse ETF volume spike initially in August during the first wave of selling. After chopping around for awhile, inverse volume spiked again, coincident with the final October low.
So this week’s lows may need to be tested as part of a bottoming process, and we may see another spike in inverse ETF volume during a retest. However, this week’s record spike in inverse ETF volume is a positive sign that traders have become too fearful, thus opening up the market to a bounce.
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Record spike in Inverse ETF Volume one sign of a bottom

Over the past 2 years, one of our favorite indicators of stock market sentiment has been the volume in inverse ETF’s. As we have discussed several times, we like to look at the relative ratio of volume in inverse ETF’s (funds that go up when the market goes down and vice-versa) to the total volume on the NYSE and Nasdaq. This indicator can give us an idea of how complacent (when the ratio is low) or fearful (when the ratio is high) traders are on a real money, real time basis.

One word of caution is that, due to the relative newness of the ETF’s, we do not have a lot of history on them or, by extension, the relative volume indicator. Therefore, we cannot be totally confident in how the indicator will behave, nor the levels that should be considered significant.

That said, we do have roughly 5 years of solid data and volume in these issues. Therefore, they can be, and have been, of vaue. Over the past few years, whenever relative inverse ETF volume has risen above roughly 1.5% of exchange volume, the stock market has tended to put in a short-term low either immediately or within days. On Wednesday, the ratio hit an all-time record of 2.5%. Now, the current decline is obviously a more serious event than any of the previous declines since the fall of 2012. Therefore, we would expect that relative inverse ETF volume might exceed recent spike levels. However, exceeding the 1.5% level by such a wide margin is certainly compelling evidence for it satisfying a bottom to the recent decline — at least, part of a bottoming process.

The previous record high in relative inverse ETF volume came on October 4, 2011 — the exact low date of the worst correction in the past 5 years. That high was 2.05%. So based on a comparison with the previous record, the recent reading again appears more than sufficient to satisfy an end or ending to the decline.

We say “ending” because, considering the nature of the current decline, we have strong suspicions that a bottom to it will unfold in a more traditional manner than the plethora of V-bottoms over the past two years. This decline has been more serious and we suspect that a V-bottom and subsequent moonshot back to the highs is not in the cards. A bottom here will quite likely include some kind of a retest of this week’s low before it is off to the races again. Therefore, this may just be the initial spike in inverse ETF volume. In the 2011 sell off, we saw inverse ETF volume spike initially in August during the first wave of selling. After chopping around for awhile, inverse volume spiked again, coincident with the final October low.

So this week’s lows may need to be tested as part of a bottoming process, and we may see another spike in inverse ETF volume during a retest. However, this week’s record spike in inverse ETF volume is a positive sign that traders have become too fearful, thus opening up the market to a bounce.

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UPDATE: The Most Significant Trendline In Equity Land = BROKEN
On September 25, we presented what we termed, The Most Important Trendline In Equity Land, namely the NYSE New Highs minus New Lows. While the divergence in New Highs over the past year was transparent and concerning, the lack of expansion in New Lows countered the concern. And as long as the well-defined trend of higher lows in the difference in New Highs-New Lows continued apace, the potential risk associated with the thinning of the cyclical rally remained at bay. Only when the uptrend in New Highs-New Lows was broken, would such “potential” risk become a realization. As of yesterday, that trend is unambiguously broken.
Now before you start complaining that the horse is already out of the barn considering the on-going near-10% correction, the broken trendline is not a short-term concern. Indeed, such extremes in New Highs-Lows often come near short-term lows. As we pointed out in the September 25 post, the concern has longer-term ramifications. Just as in September 2001 and July 2007, this trend break runs the risk of eventually leading to a more serious cyclical bear market.
So while the market is undoubtedly washed out here in the short-term and will likely form an intermediate-term low within days or weeks, the longer-term cyclical bull has now been dealt a staggering blow.
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UPDATE: The Most Significant Trendline In Equity Land = BROKEN

On September 25, we presented what we termed, The Most Important Trendline In Equity Land, namely the NYSE New Highs minus New Lows. While the divergence in New Highs over the past year was transparent and concerning, the lack of expansion in New Lows countered the concern. And as long as the well-defined trend of higher lows in the difference in New Highs-New Lows continued apace, the potential risk associated with the thinning of the cyclical rally remained at bay. Only when the uptrend in New Highs-New Lows was broken, would such “potential” risk become a realization. As of yesterday, that trend is unambiguously broken.

Now before you start complaining that the horse is already out of the barn considering the on-going near-10% correction, the broken trendline is not a short-term concern. Indeed, such extremes in New Highs-Lows often come near short-term lows. As we pointed out in the September 25 post, the concern has longer-term ramifications. Just as in September 2001 and July 2007, this trend break runs the risk of eventually leading to a more serious cyclical bear market.

So while the market is undoubtedly washed out here in the short-term and will likely form an intermediate-term low within days or weeks, the longer-term cyclical bull has now been dealt a staggering blow.

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High-volume breakdowns lead to nearby bottoms — after a flush

Yesterday, the S&P 500 accomplished a rare feat. It touched a 6-month low (before recovering) on the heaviest volume day in a year on the NYSE (not including option expiration days).

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Since 1950, such a high-volume breakdown has occurred just 14 other times, not including a few clusters of instances. The action of the stock market after such breakdowns has varied so merely looking at average returns is not the most productive method of analyzing the events. Nevertheless, here are said returns.

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As the table shows, the returns appear to be binary, with roughly half of the occurrences showing positive returns out to a month and half of them negative. The interesting thing is that the instances showing positive returns are not the same over those time periods. Some of the occurrences showed immediate positive returns over the next few days before dropping in the weeks following. Likewise, some showed further selling for several days before forming at least a short-term low and bouncing.

A couple instances, October 1987 and October 2008, saw big rallies over the following 2 days, +15% and +11% respectively. That does not appear to be in the cards for today. With the futures down sharply at the moment, let’s focus on those that saw further selling the next day. Here is the performance of those 7 dates.

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Naturally, the short-term returns, and especially drawdowns, are much worse when the breakdown days are followed by immediate weakness. The median 1-week drawdown was nearly -6%. This suggests that should the S&P 500 close lower today, the near-term risk of further large declines over the next few days is substantial.

On the positive side, the near-term weakness did not seem to effect the intermediate-term performance. Indeed, by 2 months later, the median return was better than that after all days. And by 3 months later, 6 of the 7 were higher by almost double the typical index return.

One other silver lining is that, following instances that saw immediate further selling, the market tended to bottom sooner. 6 of the 7 formed a short-term low within 7 days and 5 of them within 4 days. The instances that bounced the following day tended to eventually fail before finding a bottom. While 2 bottomed that very day, the other 5 took between 6 and 14 days to bottom.

Interestingly, other than the 1987 crash, the other instance that bottomed on the breakdown day was August 16, 2007. Bulls were hoping that that day would serve as a template for yesterday. The similarities are obvious, including the big intraday reversal (although, as we posted recently, such reversals are not reliable as longer-term turns.) With this morning’s selling pressure, we do not appear to be following that template.

The other reason to hope that August 2007 may serve as a template was its proximity to the 52-week high. Other than the current case, it was the only instance of a high-volume breakdown that came after the S&P 500 hit a 52-week high sometime within the past month. Again, that template does not appear to be panning out today.

What’s the main takeaway? These breakdowns tend to see further weakness in the days following, often significant weakness. This is especially true when the following day is down as the S&P 500 appears to be heading today. However, once the short-term selling pressure subsides, the market has tended to put in a short-term bottom within a few days or weeks. Such a bottom has led to strong, even above-average, intermediate-term rallies.

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Record spike in Crude Volatility Index may bring a bounce in oil

With the recent carnage in global equity markets, the bludgeoning taking place in the crude oil market has flown somewhat under the radar, at least until the past few days. Things are getting serious now in the oil market as evidenced by yesterday’s largest drop in several years. The United States Oil Fund, USO, is on track for its largest weekly and monthly losses in several years as well. All told, the USO is down almost 25% in the last 4 months.

Traders are now starting to take notice of the damage. One manifestation of that can be found in the Crude Oil Volatility Index, OVX. Like equity volatility indexes, such as the VIX, the OVX indicates traders’ expectations for the level of volatility in the USO. While the OVX has been higher on an absolute basis before (2008 and 2011), on a relative basis, it is seeing a historic spike. As of yesterday, the OVX was a record 126% above its 52-week low.

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As scary as the ongoing sell off in oil and concomitant rise in volatility may seem, we may be at a point representing a buying opportunity in the commodity, at least over the short to intermediate-term. That is if recent history is any indication. Since 2009, there were 5 instances in which the Crude Volatility Index jumped at least 67% off of its 52-week low. Each time, USO bounced over the following weeks and months. These were the results.

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As the table shows,  following each of these 5 occurrences, the USO was higher after 1 and 2 weeks and after 2 and 3 months — and substantially so. The smallest maximum gain among the 5 over the following 3 months was almost 15%. The 3-month point seemed to be the sweet spot from a median return perspective as the USO tended to drop after that. This is not surprising considering the fund has been in a sideways range over the entire period. That makes the positive results following the OVX spikes that much more impressive.

Obviously 5 occurrences is not a significant sample size so buying blindly without regard for risk management is not recommended. Additionally, considering the swiftness of the current decline and the fact that some key support levels have been broken, further short-term “waterfall” risk exists. It is also entirely possible that a new cyclical decline may be in force as opposed to the trading range that has persisted for the last 5 years.

However, for those that subscribe to the “buy fear” theory, your fear is here. If recent history is any guide, any further short-term weakness should eventually give way to a sizable, if temporary, intermediate-term bounce.

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European stocks *should* bounce here
On August 13, we mentioned that European stocks, as represented by the MSCI Europe Index, had bottomed a couple days prior at precisely the right spot. By right spot, we mean as suggested by Fibonacci Retracement levels (see that post for a little more info on Fibonacci numbers). These key Fibonacci levels, indicated at the 1680 level, were derived from prior lows in June 2012 and June 2013. Sure enough, the Index bounced on August 8 at precisely 1680.
As we mentioned in the post, European stocks had been deteriorating for several months already, threatening the durability of the post-2012 uptrend. Thus any bounce off that 1680 level would likely be shorter-term in nature, “weeks to months” as we put it. Indeed the MSCI Europe Index was able to bounce for exactly 4 weeks before resuming its weakness.
It has now reached the next Fibonacci “cluster” of key Fibonacci Retracement support around 1575, as signified by the following:
38.2% Fibonacci Retracement of 2012-2014 Rally ~1575.20
61.8% Fibonacci Retracement of 2013-2014 Rally ~1575.91
The MSCI Europe Index opened yesterday at 1575.90 and was able to close slightly above that level. With many global equity markets mired in quasi-waterfall type selloffs currently, the risk is greater right now that indexes will “overshoot” potential support levels. That said, the MSCI Europe Index, along with many of the individual nation markets on the continent, have already been beaten down mercilessly. Perhaps it has done its overshooting and is due for a bounce. If so, it is certainly at the “right” spot for it.
Then again, in an environment in which many indexes and stocks are being sold off beyond where they “should” bounce, there is always short-term washout risk.
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European stocks *should* bounce here

On August 13, we mentioned that European stocks, as represented by the MSCI Europe Index, had bottomed a couple days prior at precisely the right spot. By right spot, we mean as suggested by Fibonacci Retracement levels (see that post for a little more info on Fibonacci numbers). These key Fibonacci levels, indicated at the 1680 level, were derived from prior lows in June 2012 and June 2013. Sure enough, the Index bounced on August 8 at precisely 1680.

As we mentioned in the post, European stocks had been deteriorating for several months already, threatening the durability of the post-2012 uptrend. Thus any bounce off that 1680 level would likely be shorter-term in nature, “weeks to months” as we put it. Indeed the MSCI Europe Index was able to bounce for exactly 4 weeks before resuming its weakness.

It has now reached the next Fibonacci “cluster” of key Fibonacci Retracement support around 1575, as signified by the following:

  • 38.2% Fibonacci Retracement of 2012-2014 Rally ~1575.20
  • 61.8% Fibonacci Retracement of 2013-2014 Rally ~1575.91

The MSCI Europe Index opened yesterday at 1575.90 and was able to close slightly above that level. With many global equity markets mired in quasi-waterfall type selloffs currently, the risk is greater right now that indexes will “overshoot” potential support levels. That said, the MSCI Europe Index, along with many of the individual nation markets on the continent, have already been beaten down mercilessly. Perhaps it has done its overshooting and is due for a bounce. If so, it is certainly at the “right” spot for it.

Then again, in an environment in which many indexes and stocks are being sold off beyond where they “should” bounce, there is always short-term washout risk.

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10-Year Yield Near Key Levels Now
In a May 14 post, we pointed out a breakdown in the 10-Year Treasury Yields below 2.60%. Although, as we stated in the post, the next significant level of potential support was not too far below, at 2.49-2.50%. However, a break of that level opened up the 10-Year to a drop down to about 2.18%.
After a brief 3-day dip below in May, the 2.49% area held for the next few months. However, in August, that level got chipped away and, as we mentioned, it opened up the door to the 2.18% level. After a bounce the first half of September, the 10-Year has broken down, reaching near that 2.18% area today (the low on the day as of right now is 2.19%). This area represents important support due to the following factors:
the 61.8% Fibonacci Retracement of the 2013-2014 rally (~2.16%)
the acceleration of the “Taper Tantrum” burst in June 2013 that saw yields jump about 50 bps in a week.
Should this level fail to hold, the next line of support lies around 2.03% based on these factors:
the 61.8% Fibonacci Retracement of the 2012-2014 rally (~2.03%)
the breakout to 14-month highs during the “Taper Tantrum” in June 2013 (~2.03%)
Failure there would open up 10-Year Yields to new all-time lows. We are a long way from that, though (although perhaps the 30-Year Yield is starting a move towards there now). One practical takeaway is that this probably isn’t a terrible time to lock in a mortgage rate or refinance a loan — that is, if you have better credit than Ban Bernanke.
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10-Year Yield Near Key Levels Now

In a May 14 post, we pointed out a breakdown in the 10-Year Treasury Yields below 2.60%. Although, as we stated in the post, the next significant level of potential support was not too far below, at 2.49-2.50%. However, a break of that level opened up the 10-Year to a drop down to about 2.18%.

After a brief 3-day dip below in May, the 2.49% area held for the next few months. However, in August, that level got chipped away and, as we mentioned, it opened up the door to the 2.18% level. After a bounce the first half of September, the 10-Year has broken down, reaching near that 2.18% area today (the low on the day as of right now is 2.19%). This area represents important support due to the following factors:

  • the 61.8% Fibonacci Retracement of the 2013-2014 rally (~2.16%)
  • the acceleration of the “Taper Tantrum” burst in June 2013 that saw yields jump about 50 bps in a week.

Should this level fail to hold, the next line of support lies around 2.03% based on these factors:

  • the 61.8% Fibonacci Retracement of the 2012-2014 rally (~2.03%)
  • the breakout to 14-month highs during the “Taper Tantrum” in June 2013 (~2.03%)

Failure there would open up 10-Year Yields to new all-time lows. We are a long way from that, though (although perhaps the 30-Year Yield is starting a move towards there now). One practical takeaway is that this probably isn’t a terrible time to lock in a mortgage rate or refinance a loan — that is, if you have better credit than Ban Bernanke.

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S&P 500 streak above its 200-day moving average is over - what now?

All good things must come to an end. That includes the S&P 500’s streak of closing above its 200-day simple moving average which ended yesterday after 477 days. While it wasn’t the Joe DiMaggio of all-time streaks, it was the 3rd longest in history — call it the Pete Rose of streaks. Only those ending in May 1956 (628 days) and August 1998 (525 days) went longer.

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So besides a good bit of trivia, what is the significance of a long streak like this coming to an end? We took a look at other similar streaks in history to see what the aftermath was. Considering there have been only 2 streaks this long in history, we widened the net a bit to look at all streaks longer than 300 days. Since 1950, there have been 10 such streaks in the S&P 500 before the most recent one. These are the results following the culmination of the streaks.

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While the sample size is small and does not lend itself to statistically significant conclusions, superficially the takeaways are pretty clear. The S&P 500 has consistently seen further selling in the few days following the end of the streak with just 2 of the previous 10 occurrences seeing a positive return 3 days later.

In the intermediate-term, the index tended to bounce. The sweet spot was out 3 months when 7 of the 10 saw positive returns with a median returns of 4.1%, well above the median after all days of 2.5%. Yet, that outperformance did not last as the median return a year later was just 1.8%, with 4 of the 10 showing losses a year out. Therefore, 4 of the 10 occasions that ended such long streaks essentially marked a significant market top, or initial top.  

We will mention that 3 of the 4 instances showing 1-year losses occurred in the 1950’s and 1960’s. The significance of that fact isn’t merely that it was a long time ago. The more important point is that using the 200-day moving average was a much more effective tool back then. In recent years (or decades), use of the moving average has been less reliable. So it is with all forms of analysis once they become popular among the masses.

In summary, if the limited historical precedents marking the end of long S&P 500 streaks above its 200-day moving average are any guide, we can expect to see some further weakness over the next few days. By a few months out, however, stocks “should” be higher, though the sustainability of such a rally may be questionable.

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Is the volatility spike over — or just beginning?

Unless you have been in a bunker hiding from ebola, you’ve no doubt noticed the pick up in volatility across basically all asset classes. In the stock market, volatility has essentially doubled from the mid-summer extreme low levels. The rise has been enough to send the S&P 500 Volatility Index, a.k.a., VIX, to a 52-week high.

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The question on everyone’s minds now is whether the recent volatility spike has about run its course or if it’s a sign of a shift in the market environment. A historical look at other times when the VIX made a new 52-week high for the first time in at least 6 months doesn’t immediately clear things up. Here are the drawdowns (i.e., max losses) going forward in the S&P 500 after such new highs in the VIX.

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A look at the drawdowns reveals a couple things. The average drawdown after 52-week highs in the VIX are much greater than the norm. However, the median drawdowns are mostly in line with the norm. What does this tell us? It suggests that more times than not, a 52-week high in the VIX is more reflective of extreme fear levels associated with a near-term market bottom. It also suggests, however, that on occasion, the new VIX high has been a warning sign of impending bigger losses. Therefore, we cannot analyze these 52-week VIX highs in a vaccuum.

A number of times when the VIX made a 52-week high, the S&P 500 bottomed almost immediately and went on to sizable intermediate-term gains. These dates include October 1997, October 1998, March 2001 and September 2001. These instances mostly occurred after more significant weakness than we’ve seen so far, in the S&P 500 anyway. The VIX was also significantly higher on those dates. In fact, it was at least 40 in each of those instances, double what it is today.

A few times the 52-week high in the VIX occurred during or just prior to waterfall-type declines such as in October 1987, September 2008 and August 2011. While the market may be in transition to more challenging times, it does not yet have the hallmarks of that type of a crash environment.

The remaining dates led to mostly nondescript returns going forward, in the short-term and intermediate-term. Many of them had other characteristics possibly similar to our present case. That is, a new 52-week high in the VIX, but coming from a low level. Such (perhaps) similar precedents include October 1989, March 1994, April 2000 and July 2007. One common thread among those dates is that they occurred during a period of transition from a low volatility environment to a higher volatility environment. The first two transitions led to higher volatility periods that were relatively short-lived, i.e., less than a year. The other two, of course, led to longer, more serious cyclical downturns.

While it is way too soon yet to determine the significance and ramifications of the current spike in volatility, historical precedents can give us a clue as to the more likely meaning behind it. An examination of those precedents yields the conclusions that we are likely neither at a launch point of a substantial rally nor at risk of an imminent crash-type move. Current conditions do suggest that we are perhaps entering a transition from the recent low-volatility period to a higher-volatility period, with the length and difficulty of such a period is yet to be determined.

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Amid heavy selling, a light at the end of the tunnel

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On September 26, we wrote a post titled “90% Down Volume Days Have Been Good Buy Signals…With One Catch" looking at the phenomenon of 90% days. In this case, we looked at days in which at least 90% of volume on the NYSE occurred in declining stocks. Such days have often been signs of selling exhaustion and led to at least short-term, and often intermediate-term, rallies.

The one “catch” we pointed out was that the 90% Down Volume Day on September 25 occurred while the S&P 500 was within one percent of its 52-week high. A historical look at similar instances revealed that, not only were forward returns weaker than the traditional strong returns following 90% Down Days, they were much weaker than even the average returns following all days. The average 3-week return after such days was actually negative at -0.46%. Sure enough, 11 days later, the S&P 500 is down 2%.

The good news? Yesterday produced another 90% Down Volume Day on the NYSE. And if there has historically been anything more positive in the intermediate-term for stocks than a 90% Down Day, it’s been multiple 90% Down Days. Here is the chart of such multiple occurrences since 1965.

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The blue dots represent instances of 2 90% Down Volume Days occurring on the NYSE within 3 weeks (there were several periods that saw more than 2 instances within that time frame; however, we only include the 2nd occurrence on the chart.) From a mere glance, it is easy to see that several of the instances occurred at or near market bottoms of some significance. Going forward, average returns were much better than typical.

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Most of these multiple 90% Down Volume Day occurrences led to positive returns. Two thirds of the instances were positive 2 weeks later and 77% were higher by 2 months later. However there were instances when the market continued to sell off in the short-term and that possibility certainly cannot be dismissed. Some markets even continued down for several months (e.g., 1974, 2008 and 2011). Most of those such markets were already weak and vulnerable before that specific bout of selling occurred, however. Thus, our guess is that the current circumstances are not akin to those precedents.

Another interesting thing that jumps out on the chart is the frequency in which these clusters have occurred since 2009. Remember, the dots on the chart are clusters of 2 90% Down Days, not singular instances. This observation lends evidence to the fact that we have been in an all-or-nothing, risk-on, risk-off type of environment in recent years — at least much more so than is historically normal.

Speaking of recent history, instances of multiple 90% Down Volume Days since 2012 have led to especially positive returns, and with almost no drawdown. This probably should not be surprising since the market, for much of that time, has gone straight up.

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By 4 days later, 6 of the 7 instances saw the S&P 500 higher. The only occurrence that did not bounce immediately was in November 2012. However, it only took 6 days for the market to bottom following that instance and it never looked back after that. The only time the S&P 500 did not show positive intermediate-term returns (2-3 months) was following April 2012. However, the market did register a 3% gain over the 3 weeks following that instance before it resumed its decline. Here are the average returns since 2012.

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If the 2012-2014 market playbook is still valid (we have serious reasons to doubt that), the market should bounce almost immediately. Even if that is not the case, however, history suggests there is still a light at the end of the tunnel. The tunnel just may be a little bit longer. A few months from now the market “should” be higher by a fair amount.

Although, as risk managers we cannot dismiss the possibility that the light is actually a train.

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"Light at the end of the tunnel" photo by John McCullough.

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Taper This! MBS Bond ETF Breaking Out
With all the fear and loathing surrounding the Fed’s tapering of its latest bond-buying QE binge, someone forgot to tell the MBS market — at least, the iShares MBS Bond ETF (MBB), which broke out to a 2-year high yesterday. And that does not even include dividends.
Unlike the taper tantrum of June-July 2013 which sent the ETF down some 5%, MBB has been very well behaved in the face of actual tapering. After consolidating its September-May rally for the past 5 months, the ETF broke out to new highs yesterday and looks ready for the next leg upward. This is why we always rely on price instead of “conventional wisdom” or conjecture.
It’s always possible, especially considering the recent plethora of false breakouts that this could too fail. However, for now, MBB seems to be saying Taper-Shmaper.
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Taper This! MBS Bond ETF Breaking Out

With all the fear and loathing surrounding the Fed’s tapering of its latest bond-buying QE binge, someone forgot to tell the MBS market — at least, the iShares MBS Bond ETF (MBB), which broke out to a 2-year high yesterday. And that does not even include dividends.

Unlike the taper tantrum of June-July 2013 which sent the ETF down some 5%, MBB has been very well behaved in the face of actual tapering. After consolidating its September-May rally for the past 5 months, the ETF broke out to new highs yesterday and looks ready for the next leg upward. This is why we always rely on price instead of “conventional wisdom” or conjecture.

It’s always possible, especially considering the recent plethora of false breakouts that this could too fail. However, for now, MBB seems to be saying Taper-Shmaper.

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Despite yesterday’s rally, New Lows made 52 week highs

In the midst of the moonshot stock rally yesterday, something unusual happened. The number of New Lows on the NYSE (and Nasdaq) expanded to a 52-week high. After triple-checking the data to make sure we weren’t crazy, considering the Dow was up nearly 300 points, we wondered how rare this feat was. As it turns out, it’s darn rare. Since 1970, the number of NYSE New Lows set a 52-week high on 147 days. Before yesterday. the NYSE Composite closed higher on only 17 of those days.

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So is there any common thread among the 17 occerrences? They of course were all unique circumstances but, in general, they tended to follow a similar template:

  • followed a downdraft in the market
  • occurred during a sizable reversal day up
  • were part of at least a temporary bottoming process
  • was later retested (whether in days or months)

NYSE Composite returns following such days, on average, tended to be worse than typical from 1 day out to 6 months.

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Of course, the market did not follow an identical path following each of the occurrences. Some performed better in the short-term, some better in the long-term. Accordingly, we zoomed in on the results in an effort to try to identify situations among the 17 prior days that best fit yesterday’s circumstances.

One differentiator was in the daily gain in the NYSE on the days in question. Yesterday saw the NYSE gain over 1.5% on the day. Therefore, we looked at each of the 17 days that exhibited gains of at least 1% on the day. There were 5 such days prior and, while this is even a smaller sample size, the results following these days were much more positive.

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Well, those returns look better. So is this an all-clear sign? Not so fast. The 5 days reflected in the table above exhibiting outsized gains on the day mostly occurred after much more significant selling pressure (e.g., October 1987, October 1997, July 2002) than we have seen in our present circumstance. Therefore, they were a part of more significant bottoms, in duration and in magnitude.

One sign of the magnitude in selling pressure preceding these 5 occurrences was in the number of New Lows occurring on the day. The average number of New Lows on those 5 days was 641. In contrast, yesterday recorded 288, relatively few by comparison. Therefore, we categorized the 17 days by the number of New Lows occurring on the day and measured the results.

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As the table shows, results following these days that recorded more than 500 New Lows (5 occurrences) showed excellent returns in the short-term. This demonstrates the “washed-out” conditions at those times. Conversely, returns following days with less than 100 New Lows (5 occurrences) showed poor returns, especially 2 months out. Lastly, following days with between 200 and 500 New Lows (7 occurrences) like we saw yesterday showed the worst returns going forward, at least up to 1 month.

Therefore, although the market bounced strongly yesterday and closed significantly higher, the number of New Lows suggests that conditions may not be “washed out” enough to yet support a significant bounce as shown in the 2nd table. Indeed, as we are witnessing today, similar conditions have usually brought more selling pressure up to a few months.

We will reiterate that, should the market bounce somewhere in here, prior occurrences (almost unanimously) suggest that the initial low will be retested at some point. The more significant the bottom, with the greater number of New Lows, has led to larger bounces for up to several months before a retest. The more minor bottoms with fewer New Lows have led to bounces of a few days or weeks before a retest.

Then again, it’s always possible the vaunted V-Bottom comes from out of nowhere to save the day. However, today is not following that playbook that has existed for the past 2 years.

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Another Tragedy Unfolding In Greek Stocks

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Yesterday, we published a post titled “The PIIGS Are Starting To Squeal Again”, noting the deterioration in the peripheral European stock markets. Of the PIIGS, none look sicker than Greece — even sicker than Portugal if only for the fact that it has already crashed.

Back on May 14, we indicated that while the Greek Athens Stock Exchange index was sitting on short-term support and due for a “bounce”, longer-term indications were that it was set up for another Greek tragedy. Sure enough, after a 3-day scare, the stock market jumped some 20% into the June excitement surrounding the negative rates implemented by the ECB. Unfortunately, the second act is playing out as expected as well. That early June high was as far as the market would go and it’s now breaking down from a descending triangle to a new 52-week low.

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The break of the triangle suggests an eventual target in the 700’s, near the July 2013 lows. Perhaps the index’s last hope for holding here is the 61.8% Fibonacci Retracement of the 2013-14 rally. Additionally, some might argue that the formation is actually a falling wedge which would imply an eventual breakout higher. However, we will see your wedge and raise you a complex head-and-shoulders.

To simplify, we’ll just note the series of lower highs and the breakdown to 52-week lows. The implications of that are clear. Enough said.

From a longer-term perspective, we see the challenges the Athens Stock Exchange faces, and some good reasons why the index failed where it did.

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The June high came in the vicinity of the following key resistance levels:

  • 23.6% Fibonacci Retracement of the 2007-12 decline
  • 38.2% Fibonacci Retracement of the 2009-12 decline
  • 2003 and 2009-10 lows (support becomes resistance)

Therefore, even if the index is able to overcome its short-term threats, or after those threats run their course, major long-term challenges promise to continue to bring more tragedy than triumph for Greek stocks.

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Oil $ Gas ETF Head-&-Shoulders Target Achieved
In a September 15 post, we labeled the SPDR S&P Oil & Gas E&P ETF (XOP) the “most interesting chart in the world”. The basis for that moniker was the battle at the $73 level between long-term support and a short-term head-&-shoulders formation of which 73 served as the neckline. We are updating that post here to say that the short-term forces won — and won big.
Four days after the post, XOP lost the 73 level, which it had held successfully no fewer than a dozen times since breaking above it in April. From that day forward, it has dropped…and dropped…and is still dropping. In the September 15 post, we stated that “…a break of $73 would target an area around $63”. XOP achieved that target yesterday, capping a stunning 13% drop in just 13 days.
The head-&-shoulders formation is one of the most often identified, and erroneously identified, patterns among chartists. However, the head-&-shoulder pattern does exist and does still work at times. When it does, one can see why it makes for such attractive pattern to identify.
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Oil $ Gas ETF Head-&-Shoulders Target Achieved

In a September 15 post, we labeled the SPDR S&P Oil & Gas E&P ETF (XOP) the “most interesting chart in the world”. The basis for that moniker was the battle at the $73 level between long-term support and a short-term head-&-shoulders formation of which 73 served as the neckline. We are updating that post here to say that the short-term forces won — and won big.

Four days after the post, XOP lost the 73 level, which it had held successfully no fewer than a dozen times since breaking above it in April. From that day forward, it has dropped…and dropped…and is still dropping. In the September 15 post, we stated that “…a break of $73 would target an area around $63”. XOP achieved that target yesterday, capping a stunning 13% drop in just 13 days.

The head-&-shoulders formation is one of the most often identified, and erroneously identified, patterns among chartists. However, the head-&-shoulder pattern does exist and does still work at times. When it does, one can see why it makes for such attractive pattern to identify.

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