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Bad Hair Days Are Back – Is the Stock Market Oversold Enough?

Summary:
A Quick Look at a few Technical Yardsticks and Comparisons We went through numerous charts and data over the weekend to provide a snapshot of where market currently stands. This is in context with our idea that sudden downturns in the form of mini-crashes are likely to happen with very little advance warning, mainly due to market structure issues (the vast increase in systematic trading strategies) and the unique post “QE” environment. Bad hair can be dangerous! Shock-haired Pete and his bro Suck-a-thumb have been traditionally used to get children in Germany and eventually across all of Europe to behave by traumatizing them with some of the most frightening horror stories ever thought up. Everybody in Europe knows these characters, and

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A Quick Look at a few Technical Yardsticks and Comparisons

We went through numerous charts and data over the weekend to provide a snapshot of where market currently stands. This is in context with our idea that sudden downturns in the form of mini-crashes are likely to happen with very little advance warning, mainly due to market structure issues (the vast increase in systematic trading strategies) and the unique post “QE” environment.

Bad Hair Days Are Back – Is the Stock Market Oversold Enough?Bad hair can be dangerous! Shock-haired Pete and his bro Suck-a-thumb have been traditionally used to get children in Germany and eventually across all of Europe to behave by traumatizing them with some of the most frightening horror stories ever thought up. Everybody in Europe knows these characters, and everybody was scared out of his wits by these stories as a child.

An ideal template for an event related to structural issues was created by the mini-crash of August 2015, which we have last shown on 05 October in this context (see: “US Stocks and Bonds Get Clocked in Tandem”). As the chart  below shows, the entire affair took just a little more than three trading days to play out. Almost needless to say, it was completely unexpected.

The sudden decline of August 2015 happened after China’s stock market and the yuan had been under pressure for quite some time and foreign exchange outflows from China accelerated. A post-mortem suggested that the fact that treasury bonds and stocks began to decline simultaneously just as the 200 day moving averages of US benchmark indexes were violated precipitated a chain reaction, with CTAs, risk parity strategies and volatility targeting strategies egging each other on in a kind of vicious spiral of stop loss triggers going off.

Here are a few data points related to the similarly sudden and widely (but not entirely) unexpected sell-off of last week. First, here is a chart of the CBOE equity put-call ratio over the past few years compared to the SPX.

Over recent years, option traders have gradually become less fearful when the market has sold off. The last time there was genuine fear expressed was in fact in August of 2015 and again in January-early February 2016 when the market sold off to retest the lows of the August swoon.

We would conclude that the equity options put/call ratio (which is a contrary indicator) says that the wave of selling is not over yet. Next, a chart of the SPX new highs-now lows percentage index, which has been a fairly reliable indicator providing buy and sell signals on several past occasions.

The SPX new highs-now lows percentage index has given a new sell signal, and is not “oversold” yet. Note that it did not get oversold in the early February rout either, but it normally does. It may be time for it to happen again.

An Eerie Comparison

The next chart compares the NDX (Nasdaq 100), the RUT (Russell 2000) and the ten year note yield. Look carefully at the annotations.

Bad Hair Days Are Back – Is the Stock Market Oversold Enough?NDX and RUT daily and the 10-year note yield. On the day of the peak the NDX was 9.1% above its 200-day moving average. Distance between 50 and 200-day ma on the day of the peak: 6%. When the index breached the 200-day ma,  its RSI stood at 24 and it has so far posted 3 positive closes since the decline began.

The fact that the RUT had a very weak close on Friday – closing almost unchanged despite a 2.77% rebound in the NDX –  counts as a negative sign for the market. The Russell has been a leading indicator for the market for a long time, and this was so far true in this recent sell-off as well.

The next chart shows the 1987 crash in the NDX, with the relevant data compared. Please note: this is not meant to indicate that a similarly horrific crash is about to happen. We are actually more inclined to look for a typical “mini crash” here, but it cannot hurt to be aware of the possibilities.

Note that the 1987 event was also marked by rising bond yields, structural issues (portfolio insurance and index arbitrage/program trading) and a somewhat hostile climate between the US and major European allies over economic policy (the tight interest rate policy of the Bundesbank was the bone of contention at the time).

Bad Hair Days Are Back – Is the Stock Market Oversold Enough?NDX vs the 10-year yield in 1987.  On the day of the peak the NDX was 14.09% above its 200-day moving average. Distance between 50 and 200-day ma on the day of the peak: 8.45%. When it breached the 200-day ma its RSI stood at 24 (!) and it posted just two positive closes in 15 trading days. Decline from peak to low: 40.85% in 15 trading days. Decline after the breach of the 200-day ma: 31.4% in 6 trading days. The 10-year yield peaked precisely on the day the 200-day ma was broken.

Conclusion – More Selling May be in the Offing

As we already said on 05 October, this is not the time to throw caution to the wind. It will be best to wait for clear technical confirmation that the sell-off is over.

Bonus Chart: NYSE A/D Line

Interestingly, shortly before the sell-off, the cumulative NYSE advance-decline line diverged from prices for the first time in ages:

Bad Hair Days Are Back – Is the Stock Market Oversold Enough?For the first time in a long time there was a clear divergence with the a/d line. The lead time was very short, which is presumably why not many people commented on it when it happened.

Charts by: StockCharts

 

 

 

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Bad Hair Days Are Back – Is the Stock Market Oversold Enough? 
 

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