Thursday's Stock Market Gets A Wake-Up Call

by: Peter F. Way, CFA


Price-sensitive Leveraged ETFs have been reflecting far more downside prospect than upside, in dozens-to-one ratios, as seen by Market-Makers.

Are Thursday’s closing prices the beginning of a serious correction, or just a minor adjustment?

How does the balance of upside-to-downside price prospects now compare with what was seen near the market peak in 2008? And what with the VIX prospects?

Is professional investor sentiment still top-heavy enough after the day’s 2% drop to inflate concern into a pre-panic state?

Or is this just another not-uncommon test of the “B” Team’s abilities while the “big dogs” of many money-management organizations are off at beaches or mountains, vacationing?

Instead of the usual morning Emperor's Haberdasher report on the economy, Wall Street was awakened Thursday to a private-organization alarm requiring honesty in public spaces (like Chicago) which noted, despite previous glowing government recovery data, that follow-through in the supply channels was glaringly deficient-to-absent.

Would a non-government economic research organization, noted for its depth of exploration of business activity support services, like the Institute For Supply Management, bring sufficient attention and concern to the underpinnings of commercial and industrial activity to raise serious doubts about US economic well-being in the minds of the investing public?

Well, it would seem that something or someone may have.

How the stage was set

Here is the beforehand view of Market-Makers for the upside price change prospects for over three dozen Exchange Traded Funds, ETFs, in comparison with their actual worst-case price drawdowns following prior MM forecasts with similar upside-to-downside expectations.

(used with permission)

In this map, attractive investments are down and to the right, fearful ones up and to the left, since the vertical loss scale in red increases as it rises. The modest upside of Proshares Ultra NASDAQ Biotechnology ETF (NASDAQ:BIB) at [20] is staggered by the overwhelming flood of prior capital-consuming price drawdown risk exposures in some near three dozen other leveraged ETFs.

The upside part of these forecasts come from the self-protective hedging actions of Market-Makers [MMs] as they must put firm capital at risk to fill the rest of big-money fund client orders where other investors demur.

Just as MM intelligent behaviors define their expectations for these most price-sensitive ETFs, the balance of both good and bad prospects are revealed every day for over 2,000 widely-held and actively-traded equity investments. The common denominators of those outlooks allow an encompassing picture to be assembled of forward-looking current market sentiment.

Their assembly is aided by representing the upside-to-downside balance in each by a measure we call the Range Index [RI]. Its value is the percentage of each equity's whole forecast range that lies below its current market quote. Low RIs are attractive buys, usually.

Here is the present distribution of RIs at today's close:

Click to enlarge

And what it was just before the day's -2% drop:

Big deal! The market takes its biggest one-day hit in months, and this is all the change we get? Didn't anything get cheaper? Why aren't there more low Range Index issues, down there below 10 or 20?

Even at the extremes, it looks like there are now a few less really cheap stocks and ETFs there on the left, and several more very expensive ones at the right between yesterday and today. What gives?

What is not obvious is that price expectations went down more than prices did. That widened the average forecast range below the now lower market quotes, making more higher RI issues. Please note that the average Range Index of these 2500+ issues now is 35.2, was 34.6 yesterday.

And what happens to a stock selling up near the top of its forecast range if the forecast comes down more than the price does? That's right, the price may be left Above the forecast, or a RI greater than 100. Its price comes down, but it gets more expensive in terms of expectations. That's what happened to a lot of the issues with RIs above 120, over there on the right-hand extreme. Many more of them.

Implications of that as a continuing trend

Not good, huh?

Pushed to an extreme, then nearly everything gets overpriced, ought to be sold. Investors start to think that way, and act that way. Then, Katy-bar-the-doors, and the panic is on.

No, in a healthy market (i.e. an attractively-priced one for buyers) lower prices bring in bargain hunters, whose buying tends to push expectations up. Making things even more attractive if anticipations rise more than prices. Double, double, boil and bubble...

Or in a panic market, ultimately that point gets reached where more bargain-buyers are drawn in than sellers are fleeing, and the supply-demand balance becomes healthier.

The way RI distributions appeared at crucial points in the 2008-2009 financial crisis is highlighted in this article.

So, while we can measure how this balancing act is progressing, its pace tends to be a bit glacial for the hot-hand hedge-fund guys. Or for anyone else concerned with the next couple of months. That is why we tend to look to the Leveraged Long ETFs for a more active sense of how sentiment may be changing. A 3x multiplier on prices tends to gear up expectations as well. And since leverage cuts both ways, the players in long ETFs tend to be more precise, and more careful.

As many contributors to SA have explained, the leveraged short ETFs have an inherent destructive bias built into their situations. To play that bias typically involves complexity of activities that may be prohibited for some, and is taxing in many ways for others. Best to stick with the simpler Long Leveraged ETFs.

So, how do they look the morning after?

Still not quite that great, eh?

Yeah, some of their forecasts came down a bit too. But for many, their day will probably come, just not today or tomorrow. Here are quick looks at a few Block Trader Forecast pictures of ETFs we have recently used as illustrations of how full prices had gotten.


The Direxion Daily MidCap Bull 3x Shares (NYSEARCA:MIDU) has been an ETF that MMs have had pretty accurately in their price sights.

Click to enlarge

This has almost made the full transit across its forecast range, and its win odds are high and payoff big enough to make it worth a nibble here, but when price and expectations are both declining it is smart to diversify buys across more than one day.

The ProShares UltraPro Russell 2000 (NYSEARCA:URTY) has been one of the more extreme movers, and today's experience adds to that record. Because its expectations did not drop nearly as much as its price (but may yet do so) for the present it has no prior history at this extreme a Range Index.

Click to enlarge

Some part of a position could be started here, with intention to time-diversify further in coming days.

ProShares UltraPro Dow30 (NYSEARCA:UDOW) is a third candidate to consider.

Click to enlarge

This appears to be a viable buy candidate here, with the same caveat as others of scaling into a position across days to accomplish some time diversity. Win odds are a bit lower than the 7 out of 8 we prefer, and the sample's small size is a function of it being at a price extreme.

The usual disclaimers found on the website apply here. The forecast opinions expressed are those implied by the actions of other professionals, subject to the information available at the time, and subject to change without notice, without any guarantees. Actions taken in times of market change may increase risks, but also often provide opportunity for increased returns.

We hope to provide a current review of VIX and its related ETFs over the weekend.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.