Equities Market — Use Extreme Caution if You're Trying to Bottom Fish

People looking for the bottom so far:
I would cover my shorts in the next 10 days, because I think the market is very close to approaching an intermediate low from which we will rebound. - on CNBC 
For the decline to be able to resume in a sustainable manner, a short term bounce from here should be expected as early as this Friday's session in order to clear some of the fear (there isn't much yet, as the VIX is still at about 25) and oversold situation of the markets. 
I'm contemplating the idea of going long the ES for a few days, with a very tight stop.
At present we observe a strong surge in put buying, so some fear has returned. However, the current put buying extremes are not yet as pronounced as to make a near term low highly probable. In all likelihood the 200-day moving average will be tested at a minimum – incidentally this is also a region where strong lateral support exists. To be sure, this level is not too far away.

And yet, we would recommend not to be too hasty with trying to catch this particular falling knife. We have just experienced how extraordinarily stretched bearish sentiment can become in the gold sector, which has fallen far below the point where we initially thought it might find support. Something similar could also happen to the broader market.
Occasionally, markets can fall heavily even when they are already oversold and bullish sentiment has already evaporated, i.e. conditions similar to today. We therefore worry that we have made a mistake in taking profits on our bearish holdings and that we won't get the opportunity to re-establish those positions on a short term bounce. We note this worry today as the Facebook IPO yesterday was seen as a "faltering start" according to the front page of the FT. 
[...] Markets appear to be oversold and bullish sentiment has evaporated during the recent decline. We have taken profits on our bearish holdings and we think there may well be a bounce in the next week or two. We think that the best strategy in the next few weeks is to use any bounce to re-establish our bearish holdings.
Over the past 10 days, the average of those two figures is 73%, meaning about 73% of the points gained or lost in the component stocks were lost, and about 73% of the volume flowed into issues down on the day. There have been four other days that match or exceed this reading – 7/22/02, 10/9/08, 7/2/10 and 8/4/11. They were each within days of vicious market bounces.

The Market Climate is characterized by unfavorable valuations, unfavorable market action, and a continued army of hostile syndromes that have historically been associated with unusually steep market losses over the following 6-18 month period. On a very short horizon, the market appears significantly compressed and open to a standard "fast, furious, prone-to-failure" bout of short covering in order to clear that condition. The problem here is that economic conditions are beginning to surprise significantly on the downside (see last week's Philly Fed report), and credit strains are rapidly increasing in Europe. So barring some monetary intervention, shorts may not be particularly inclined to cover much here. In that event, the failure of the market to provide a relief advance could produce something of a run for the exits as managers holding high-beta positions cry "Uncle!" into a market that isn't particularly willing to absorb those positions without a significant discount. For that reason, I have no particular view about short-term market direction, except that it is likely to be a roller-coaster of sorts. Hold on to your hat.
  • Tiho, on the ShortSideOfLong blog writes:
I want to buy S&P 500 Calls soon. I am still waiting for signs of a bottom in the equity market sell off. Short term capitulation could be near, followed by a rally - even a very powerful one. Eventually, as we recover weeks or months from now, I want to short stocks.
Carl Futia
I think the end of the drop from 1419.75 is imminent.
What makes me doubt we've reached the real bottom is:

  • Too many people seem to be bottom calling, even though they are very smart and worth to follow investors.
  • The equity PC ratio has jumped to an extremely high level, but the VIX remains at the same time extremely low. This could be a major non-confirmation factor.

No comments: