In recent days it has become increasingly difficult to predict the near term (a few weeks) direction of the markets. Clearly the
longer term trend is lower, but some indicators suggest a bounce might be near while others disagree. Lets start with the Nasdaq 100 tracking etf QQQQ which makes the strongest argument for a near term bottom:
From a
measured move standpoint, the Q's have completed the recent leg down by dropping an equal percentage to the fist leg (11.6%). In
Elliot wave theory this could be viewed two ways, either as the end of an
ABC correction or as the first three waves of the
first impulse in a long term down trend. The longer term implications of which interpretation you use is dramatic since if this is just a simple ABC correction then we would now resume the long term uptrend and make new highs. Obviously, I don't think that this is just a correction in a longer term uptrend, but for the short term it doesn't really matter which interpretation you use because in either case we should move higher.
Furthermore, the QQQQ recently reached oversold levels on the RSI seen at the August and November lows. Similarly, the stochastics gave buy signals (note the blue circles above). This chart was so compelling to me that I took significant call positions in the tech leaders SIGM and WFR on Friday.
On the other hand, although the underlying economic conditions have worsened substantially, we are not seeing the level of panic or bearishness than existed at the August and November lows. This might sound like a vague claim to make but we can quantitatively look at "panic" and bearishness a few ways. The standard way to do it is with the
volatility index, or VIX. Also known as the "fear gauge," the VIX is a measure of the implied volatility of the S&P 500 index options. Volatility usually peaks at turning points, especially at bottoms, as can be seen in the six month chart below:
The VIX hasn't spiked like it did at recent bottoms and remains low compared to August levels. The caveat to this is that the VIX made a higher low recently and appears to be in a longer term uptrend. This suggests that volatility will be going higher eventually whether or not it does right now. To me this chart says people are not too concerned about the markets, we are just having an orderly sell-off that could continue. In general, volatility tends to go up in declining markets because investors buy insurance on their holdings by purchasing puts. The increased demand for puts causes them to be more expensive and so the VIX rises. When people panic and start loading up on puts that can signal a bottom, we are not there yet on the VIX. I'd also note that the VIX has historically seen much higher levels than we are at now, so there is room for the "fear gauge" to increase substantially.
In addition, volume tends to spike at turning points. Looking at the QQQQ volume in August and November (in the top chart), we saw a huge volume day at the recent bottoms which tells me that people panicked and threw away stocks. We haven't had such a day yet in this decline where volume spikes and VIX pops.
Another indicator I wanted to point out was the put to call ratio seen above. Like the VIX, the put to call ratio tends to spike at market bottoms and be low at market tops. You can clearly see the extremes in the chart above which correlated well with recent market turning points. While the put to call ratio did spike to a level that would be considered high over the last six months, it only reached around 1.0. That means that there are just as many calls being held out there as puts, which is hardly bullish.
The NYSE new highs - new lows index (seen below), NYHL, paints a more bearish picture being far above August levels. While it did make a recent low, this index is clearly declining and seems headed lower. This index would be zero if an equal number of NYSE stocks were making new highs as were making new lows and it becomes increasingly negative as more stocks make new lows. The fact that the 50 dma is below the 200 dma and both are declining tells me this market is sick:
The last indicator I wanted to throw out there is kind of obscure but I thought I'd mention it because it suggests that we are at a very extreme condition right now. Its called the NYSE
short term trading arms index, the ticker is TRIN. "A number of TRIN interpretations have evolved over the years. Richard Arms, the originator, uses the TRIN to detect extreme conditions in the market. He considers the market to be overbought when the 10-day moving average of the TRIN declines below .8 and oversold when it moves above 1.2. Other interpretations seek to use the direction and absolute level of the TRIN to determine bullish and bearish scenarios. In the momentum driven markets, the TRIN can remain oversold or overbought for extended periods of time." I have the 10 day moving average shown and the .8 and 1.2 levels marked with the oversold levels circled. Those areas should be places you want to be buying. Note that this index is saying that right now the market is the most it has been oversold in the past six months which would suggest a tremendous buying opportunity:
The point I'm trying to make here is that the market is flashing contradicting indicators on the shorter term (a few weeks) direction of the market. This could indicate that the next big move is relatively unexpected or it might indicate that there won't be a big move soon. Maybe the market will just go flat in which case a lower VIX at this "turning point" would make sense. We'll just have to see. One thing is certain, it isn't getting any easier to make money trading this market.
As a side note, all five of the above charts are of the last six months so you can scroll up and down this post and see how they are correlated.
One reader had a nice metaphor for today's action in saying that "stocks rocket up their rears as they fell off the cliff and ignited the rocket midair." This was precisely the action I cautioned about last night when I said to "be aware that if a breakdown reversed it would also turn out to be a powerful move back up, so stops are essential either way you play this." I feel more confident than ever that the bottom is in for 2008.
Note that the divergence in the RSI and CCI on the VIX and especially note that the CCI flipped back below zero again. If the VIX were a stock I'd be shorting it right now, itjust needs to break that 50 dma to confirm the intermediate term downtrend. And its the same story with the put to call ratio, positive divergence over the past month (lower highs despite stocks making a lower low):
And perhaps the most compelling indicator of all is the extreme divergence in the new highs-new lows index. It made an all time low of -2477 at the October low but has managed to climb back to roughly 600 since. This demonstrates that the underlying market technicals have dramatically improved since the October lows and also that we saw a historic level of panic last month that we were no where near today (despite lower prices breifly today). Try plotting this on a longer term chart and you will find that downward spikes match up precicely with major market lows and you will also notice that the October spike down was much, much greater than any before it.
Finally, these are crazy times and in crazy times people will look for anything they can to find order amidst the chaos. One strategy I heard nothing about in the bull market (because its silly) but have heard alot about recently is the use of astrology in technical analysis. That is, basing investment decisions on the phase of the moon, planets and stars. Believe me or not, it is becoming increasingly popular to connect the cycles of the stock market to the cycles of the moon. Now I wouldn't put much weight in this other than that over the past few weeks I have heard some highly accredited investors (Art Cashin and Robert McHugh among others) say that today would be the day of the market bottom based on today's full moon (and other things of course). Well, needless to say those people were vindicated with today's epic full moon failed breakdown reversal. I think we all owe the moon a round of applause, go moon!
