The markets have been unusually active since Thanksgiving. During the last five days, we saw the worst price action for markets in a few years:
- The Dow Industrials dropped nearly 800 points from the high it set on Monday morning
- The SPX 500 fell a staggering 3.7%, also off of an all-time high
- The Russell 2K dropped as well, but not nearly as much
The culprit is crude oil. Since Thanksgiving, crude has steadily cascaded lower, reaching a 5-year low. Unless some intervention occurs, it appears oil prices could continue to slide.
For its part, crude oil fell about 12% on the week. We have seen many investors try to catch the falling knife, but with oil volatility so high (see the OVX chart below), it makes little sense to try and call a bottom. With volatility at these high levels, option prices are juiced up, so there is no advantage in buying or selling premium (normally a great strategy when volatility spikes).
The VIX moved nearly 100% over the past five days, and it was this action that caused a major concern. On Friday, December 5, w saw volatility at/near its lowest point of the year, with the VIX clocking in under 12%. That’s a dangerously complacent level, and I spoke about the caution here.
Recent spikes in VIX have been great areas for reversals WHEN THEY HAPPEN – NOT BEFORE – but this time around everyone who wants to buy protection is getting on board early so they can cash in when volatility spikes lower (this is a marked change in the pattern of buying protection, which usually seems to occur at the end of a big run). We’ll have to see if a high spike occurs quickly this time around.
One of the most reliable reversal tools has been the VIX/VXV ratio. These indicators track 30 days of volatility and 90 days of volatility, respectively. In a bull market, a ratio over one is not sustainable for long.
As my friend Steven Place of Investing With Options says, it is the place to buy the blood (see chart below). We chatted in mid-October about this when the ratio spiked over one, and while the condition lasted for about five days, it triggered a very powerful SPX 500 run of more than 190 handles up!
From my perspective, the odds favor a turn HIGHER in the markets in the next couple of days, and we’ll play it that way.
The VIX term structure is something I watch closely, and my friend Jay Wolberg shares some great charts and statistics each day on Trading Volatility. Currently, the VIX cash is above many of the futures, as the reach for protection is extremely short term. However, the curve has flattened significantly, much like in mid-October when the term structure actually inverted for several days. That was a temporary condition and the curve soon normalized and morphed back into a bullish construct. I suspect this time around the worry is short-lived.
Breadth has been worrisome of late, though. Given the amount of selling and the shock from dropping crude, those who have been long on stocks and are being forced to sell (as we saw this happen late Friday) are getting out of the way. Buyers have stepped aside, too. The MC oscillators are well oversold – the NYSE came in Friday at a ridiculously low -201 while the Nasdaq clocked in at -96. These are extreme oversold readings.
Next week brings a big convergence of data and events that may swing the markets. We are entering a seasonally strong period for stocks, and while that has not been the case so far this month, we could see the tide turn with all of the bearish sentiment stacked high.
The Fed will have their last meeting of 2014, and I suspect no change. They will bring us a revised forecast, and Janet Yellen will hold a press conference. A slew of important economic data is forthcoming, and some key earnings will be released by big names like Nike (NKE), Oracle (ORCL), FedEx (FDX), Accenture (ACN), Genreal Mills (GIS), and Carmax (KMX), among others. This week is also a big options expiration week, and that’ll have a major effect on price action as we end the week.
The speed of the above-mentioned moves down brings with it a great deal of worry and doubt. We’ve been saying it for awhile: The market is in need of a bigger correction, but we won’t make the timing call. Why is that? Simply put, the market will see a reason to correct – and perhaps move towards a bear market – and it will TELL US beforehand. The stock market is a great discounting mechanism that never fails, so there is really no sense in trying to guess a move.
Santa Claus comes to town for the seasonal rally on December 24, which will last until January 5. We’ll have to see if he’s bringing presents to Wall Street – or lumps of coal.