Bear Market Rally ETFs: Is Capitulation Close?

Do you surrender? Do you give in? The rest of the market participants are darn close to doing so.

The problem with the idea of stock market capitulation is that it's nearly impossible to predict. In fact, most of the time, we use 20/20 hindsight to identify it.

There are some signs, however. For example, near the March 2007 lows, you had the put/call ratio hit 1.0. Yesterday, the equity put/call ratio only registered 0.71. That might suggest we have further to fall. (Re-read, "Extreme Bearishness Will Tell You When To Buy.")

Back in March, you also had investors throw out the resource stock babies with the drinking water. Same thing happened here on the 2nd of July. And that might be quite telling. Today, the remaining strongholds of Metals/Mining (XME), Materials (XLB) and Energy (XLE) dropped 3% or greater. This was on a day when commodity prices kept climbing AND Financials (XLF) didn't fall quite as far (-1.5%).

So perhaps we are closing in on the point in time when investors have collectively decided that they've had enough. Perhaps we are nearing that place where the majority of folks prefer to take their lumps.

When this happens... when all of those who wanted out have done so... only buyers are left. And they drive the prices back up. In fact, prices will go up, whether the rally is for real or whether it's merely another rally in the bear.

Either way, stocks are going to get a summer reprieve. The question is... which group of stocks?

In my estimation, we are likely to see a high correlation between what worked off the March lows and what will work off of the July lows. (I am assuming we'll put in a "July bottom.")

So let's review a chart from March and a chart from today:

The pattern is eerily similar. When the markets capitulated in March, financials had sold off about as much as they were going to sell off. In contrast, people who had been holding onto gains of their remaining winners reluctantly sold resource-related companies.

If capitulation has occurred, which I am not saying it has, the question turns to the stock assets that ran the strongest in the 2-month rally from March 20 to May 19. The chart below shows that Materials (XLB) and Energy (XLE) reigned supreme.

Again, I am not suggesting that we necessarily witnessed capitulation yesterday. Honestly, there may not have been enough fear in the CBOE Volatility Index nor the CBOE Equity Put/Call Ratio.

Nevertheless, the resources baby should probably not be thrown out with the bath water; in particular, if there's going to be a bear market rally (or a real rally), expect that leadership will stay the same in the near-term.

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Comments

[MSmailbox]

Very wise asessment... It happens to be what most of of *want* to hear, but that DOES NOT mean that it's wrong! Based on the assumptions, which are few, this could very well play out.

[whidbey]

Will Blink is correct, just when you found a port in the storm things get worse. It is not the bottom and capitulation is a military concept. We are about to enter a down trend in employment in two large sectors, autos and shelter. The Congress is going to bail-out a few homeowners, banks and builders. Yes, they will. and you will be shocked when the consumer dies from energy fatigue and stops spending down to about 50%. It is called the Ice Age: a frozen economy. Think Japan. Nice ideas Gary, but no cigar, not even the wrapper.

[SA2]

Interesting and well thought-out analysis!

Thank you for sharing.

[BrucePile]

The VIX hasn't quite gone to the turn area of around 30 (it's been to around 26 or so) but you can have bottoms short of 30+.
The oil stocks will likely be the most bouyant off the low. They seem to be still priced for $70-$90 oil and have started a strong repricing for $120 and beyond. Oil could plateau for awhile at $120-$140, and these stocks would still probably experience a strong climb.

[squashnut]

The cash on the sidelines will go more directly into food, energy, clothes, and health care, nicely cutting out the stock investment middleman, who will have to sell his stocks to feed himself, as he will be out of thousands of jobs.

[squashnut]

I see now that the ownership society may exert pressure to become the bailout society, but the banksters day may be coming.

[Kunst]

The market is oversold. Let the powers that be poke even a temporary hold in the oil bubble and stocks will take off like a startled jackrabbit.

[Bandit21]

I don't think we are near the bottom. This financial crisis has a lot more bad things to drop on us. Our Financial system is in danger. I suspect that the blowout capitulation probablywill be triggered by a terrible event with a disasterous sell off. But I'm thinking the event may be so bad that the market will take a long time to recover. Maybe I'm too gloomy. I hope so.