In 18 market days the S&P500 has dropped -7¼% in price. Market-maker hedges against declines indicate the reduction in downside expectations have been directly in line with prices.
Their hedging on the upside has been more optimistic, marking sell targets on the index down by only -4.8%.
The Nasdaq 100 index in the same period is off -8.8% in price, and hedging against it has pulled downside exposure targets down by -7.6% and upside sell targets off by -6.8%.
Has this much of a pullback been enough to put a solid floor under a post-election, 2013 market rally?
Perhaps not, when put in the perspective of prior experiences with broad market indexes and currently available investment instruments to work with (and on) them.
We daily maintain implied price change prospects on over 2,000 widely held stocks, ETFs, and indexes, inferred from the hedging activities of the professional market-making community as they go about their essential work of providing market liquidity, facilitating orderly transactions in the tradeable securities.
The denomination of their expectations in terms of percentage price change potentials in both upside and downside prospects makes possible direct comparisons between investments of widely varied character and competitive circumstances. Group or portfolio and ETF comparisons become simplified.
The history of the evolution of their expectations, backed up by capital put at risk, provides a broad market perspective not available elsewhere.
Here is the present picture of their defenses against possible price change in an array of widely-followed market indexes and the ETFs tracking them.
These 20 indexes and ETFs now are being viewed in very similar circumstances to one another, of both limited upside potential and limited downside exposure.
The dotted diagonal line marks the points where upside and downside are equal, so all of these are being viewed positively, on balance.
In contrast, less than a month ago a number of them were regarded as having as much or more downside as upside.
Present-day ETFs offer a variety of leverage effects made possible by the structuring of the funds and their use of derivative securities, rather than by financial leverage through the investment of borrowed capital.
Those ETFs, by design, are more price sensitive to investors' value perceptions than the underlying indexes they are designed to track.
Here is how they were being appraised at that earlier date of higher market index prices.
The differences in their prospects are clearly magnified, and several are at this earlier time viewed as being at risk, on balance.
Currently, the retreat in prices has cured the overvaluation of most of them. It has also put several of the levered ETFs down at a point where their current prices are below their reasonable downside expectations.
Not to be confused with a "can't lose" situation, the examination of prior such experiences usually shows odds-on cases of likely subsequent price advance.
But this does not help much in estimating how close to a market bottom we may now be.
Unfortunately for our comparisons, there are now five times as many leveraged ETFs as there were back in March of 2009, the last market low.
But there were then most of the broad market index ETFs we now track and trade, shown in the first such picture, so we can better use them for comparison purposes.
What is evident in this picture is that the upside potentials in 2009 were perceived to be much stronger, and the differences between the various indexes were much more marked. Several were so depressed that they were being traded at prices below what was held to be reasonable by the market-makers. At present, that is not yet the case.
To understand what was happening at the time of the March 2009 low, and why the market finally turned up, it may help to see how the whole equity investment population that we cover was behaving. And then to see how it looks now.
Because we have this common denominator of potential percentage price change - in each direction - we can fractionate the population in terms of the size of potential change. At different points in time there has been variation in the number of investment vehicles with gain - and loss - potentials of specific sizes.
To begin with, here is what the average distribution of perceived upside prospects for equity investments has been, daily, over the past twelve years of fluctuating markets. The average proportions are in the blue columns.
Each colored line shows the population proportions at a specific date. Red is the market's high in 2007; green the March 2009 low; yellow is now, and purple the most recent high a few weeks ago.
Now check out how the downside proportions have differed from the upside variations from average at the same specific dates. Whereas the upsides basically shifted the same shape of proportions contra-cyclically across levels of prospective price change, the downsides have changed their proportion shapes.
At market peak in 2007 the downsides looked very normal - no warning of the coming decline. All the warning was in the upside shift. After the initial rapid decline in the last two months of 2008, it took another two months of grinding lower prices to scare the investment community that it was likely to continue to have disproportionately larger price declines (green line) in greater magnitude than average, before the upturn.
But now we have the shape disparity.
Where investment anticipations of possible decline are now, is where they have been for several months - in denial. The apparent belief that usual-sized price drops won't happen may now be seriously tested.
There are several dimensions of potential market stress that could turn denial into panic. That is not a forecast that it must, or that it will, just that it could. Among the possibilities are all the things well recognized and discussed - fiscal cliff, debt ceiling, U.S. political lockjaw, Syrian Revolution, Mideast war, the Euro's potential (inevitable?) dissolution, perhaps even highly destructive national social revolutions in the process of that breakup.
Our only contribution here is a warning that the current state of downside denial raises the potential for a much more serious (and potentially more sudden) market decline than generally expected.