Market Futures Point to Imminent Correction

Includes: IYR, SPY
by: Peter Cooper

A surge in put or sell options in New York and a decline in call or buy options is a classic signal of a stock market trend reversal, and is now in place. On Friday the S&P 500 also registered its biggest percentage fall in almost a month.

Then again, on Friday 89 per cent of stocks in the S&P 500 traded above their 50-day moving average, and by definition a trend line above an average is not sustainable.

Indian rate hike

On Monday Indian stocks will lead the downturn after a surprise interest hike after hours on Friday. Meanwhile, renewed fears over the Greek debt crisis have floored the euro again.

In the US, housing dominates the statistical show next week. Housing has been the component of the US recovery that has failed to come right so far. Existing home sales are out on Tuesday and new home sales on Wednesday.

It is also uncertain how President Obama’s controversial healthcare bill will be received by financial markets. This removes uncertainty but the cost of the measures may be judged anti-business. Then again, Google (NASDAQ:GOOG) pulling out of China is hardly a positive.

On Friday, the dollar gained against all major 16 currencies. This is an indicator of what to expect in a big market sell-off. Bond yields will take a dip and prices jump. All commodity prices, including precious metals, will fall.

The flight to the dollar and bonds as a safe haven has started. Partly this is an automatic response to the liquidation of assets like stocks that are denominated in dollars. Partly it is a shift from risky assets to a perceived safe haven.

How long will this dollar rally and stock market correction take? Stock markets generally correct much faster than they rally. So a 12-month rally might be followed by a three-month fall, or it could be an even quicker correction.

Size matters

However, the higher and longer a market rally logic suggests, the harder and longer the fall. In previous bear market rallies after major financial crises the correction has generally been to a new low and over a matter of several months.

Institutional investors have also been replicating hedge fund strategies so that they can liquidate faster than possible with hedge fund withdrawals. That could add significantly to the velocity of the next downturn.

So successful has the Fed been in sustaining this rally that most investors have forgotten that this now leaves the emperor with no clothes, as the liquidity is spent and it is impossible to lower interest rates meaningfully – and that is how 20 per cent corrections are usually capped.

Is it too late to short the S&P 500 at this point?

Disclosure: No positions