Making Sense of the Current Market Weakness

The indicator reviews of late have indicated a stalling out of the market bounce since mid-July, with negative dollar flows into stocks and more evidence of sector rotation than actual sector trending. With Monday's reversal, we've seen a steady selling sentiment hit the stock market, taking us to multi-week price lows. Here are a few thoughts on the market action:

Fear Goes Up - I mentioned a little while ago that the VIX had broken to the upside and that readership of this blog, which seems to swell during periods of market weakness, was more consistent with levels we see at market tops than bottoms. Well, on Thursday, the number of visits to the blog swelled by 40%. An hourly view of readership indicated that visits to the blog expanded precisely at the time the major indexes were breaking below their multi-day support levels.

This doesn't necessarily mean we're at a bottom, but the jump in the VIX to 24 and the expansion of interest in psychology themes suggest that one element associated with bottoming processes has now entered the picture.

Institutional fear has been on the rise as well, with credit-default swaps on the rise. That means that it costs more to protect corporate bonds from default: a useful indicator of fears regarding economic weakness. We've yet to see equity put option volume exceed equity call option volume on a multi-day basis; that's been one sentiment indication that has been present at recent intermediate-term bottoms. Nor is the percentage of stocks trading above their 20-day moving averages at levels normally seen at bottoms. Fear is up, but several indicators suggest we could have more to go.

This is a Global Affair - The striking feature of the recent weakness is that it is associated with a strong U.S. dollar (the dollar index is up about 10% from its July low) and weak commodities (the CRB Index has fallen roughly 20% from its highs. Emerging market stocks are leading the downside, with iShares MSCI Emerging Market Index (EEM) down by roughly a third since May and now hitting new lows.

Global weakness is the theme: That is weighing on commodity prices, and it is making the U.S. dollar a relative safe haven. If I had to opine, I'd say that the market is voting that the countries that have been fighting inflation by maintaining high interest rates have gotten it wrong. As a result, they will be looking at recessions more severe than they would have been otherwise.

According to Bloomberg, global markets have lost $17 trillion since the market top in 2007, with global financial companies down 29%. Incredibly, China's Shanghai A index has fallen from over 6000 late last year to about 2300 at present. Russia's RTS Index is down about 40% just since May. This is not just about the U.S.; in relative terms, the U.S. is outperforming many global equity markets.

Keep An Eye on Participation to the Downside - We're seeing new lows among energy, utility, and materials shares. The broad NYSE Index has moved to new price lows for the year, as has the NASDAQ 100 Index, but the advance-decline lines specific to common stocks in those indexes has not yet made new lows. We had 417 new 20-day highs among NYSE, NASDAQ, and ASE stocks on Thursday, against 1863 lows--a clear widening of weakness. Demand, my index of the number of stocks closing above their volatility envelopes, was 17; Supply was 187: a very skewed reading.

Still, among NYSE common stocks, we only had 10 52-week highs and 99 lows. Compare that with about 450 new lows in mid-July and 700 new lows in January. A number of sectors, such as Consumer Discretionary and even many of the Financial shares, remain well above their July lows. It is not at all clear to me that this will be a fresh bear market leg down. I'm open to the idea that this may be an ultimately successful test of the July lows and part of a larger--and quite significant--bottoming process. Participation to the downside will tell the story.

Comments

[Jackson Cash:]

DOW at 8.5k (or less) before we see any sort of "real" bottom. Money (value and writeoffs) is evaporating faster than a boiling pot of water and the consumer is the Lobster.

2008 Sep 05 11:26 AM

[MarvinMBA:]

Lets face it...the stock market is just doing a great job of getting rid of excess liquidity. If you have excess liquidity stick around and the problem will be corrected. Thats what the market does...provide liquidity or remove liquidity. In this case the excess money finds itself in the market and the excess is eliminated. When you decide that your personal excess capital is removed than you will leave..until then you can wait for the market to create liquidity and that IMHO could be 10 years off but it might be five or it might be twenty...your choice..Marvin the Maven

2008 Sep 05 11:44 AM

[statsdoc:]

As long as there are people that are still calling the bottom, we have not yet reached the bottom. You would think people would learn from previous markets. I don't remember anyone calling the bottom correctly in previous bear markets. Yet, this time it must be apparent to a lot of people.

2008 Sep 05 11:51 AM

[Carl Spackler:]

It is simple economics - because banks and financial institutions are reducing loans dramatically, we have been deleveraging on a worldwide basis. That is like sucking trillions of dollars out of the world money system. Less money to chase all types of assets means lower commodities, lower stocks, lower real estate prices etc....

Nothing the Fed can do about it - they have lowered rates 6 times and yet mortgage rates and other borrowing costs are actually higher now! This recession will behave differently as a result. We will not pull out of it like in past ones.

2008 Sep 05 12:21 PM

[investor88:]

Bret's article ends by saying he is open to the idea this is the bottoming process. However the preceding 4 commentators disagree, we cannot fathom the market bottom at this stage with so many negative factors. On balance of evidence I tend to agree with the view contrary to Bret's, ie best to lay off and preserve capital or short some for a trade. This is no time yet for bottom fishing?

2008 Sep 05 12:22 PM

[investor88:]

Carl and user118015 have articulated very pertinent forces at work decimating asset prices, ie there is massive DELEVERAGING like a dam breaking, LIQUIDITY is being sucked out of the system causing asset price contraction. Those who recognise the strength of these destructive forces will want to step aside and not stand in the way of the freight train, except possibly to build suitable short positions from time to time.

2008 Sep 05 12:29 PM

[dieuwer:]

Contrarianism is just a boatload of crap.
"If I bang my head against the wall it will hurt, consequently I will short health care stocks because I really do not need them?" Yeah right...

2008 Sep 05 12:36 PM

[Jason Rines...:]

Buckled up, thats for sure. To your point Wyosteven, I attempted to refinance last remaining debts I have with my bank. They said no, they are shedding the majority of consumer credit lines. I can try my business bank. Consider my credit rating is excellent and I do have what most here would have considered ample collateral a year ago. There is no where to run for the consumer and no where to hide. Washington had best get moving on serious job creation on energy and other infrastructure, Hoover style. Food pantries like the soup kitchens of old are going to be packed and numbers suggest this is already occuring. Do be gentlemen and help out while you protect your family.

2008 Sep 05 05:51 PM

[Socialism c...:]

"I'd say that the market is voting that the countries that have been fighting inflation by maintaining high interest rates have gotten it wrong."

And how else do they fight inflation? That in itself was not wrong. The problem is that there are no barriers to global contagions. Tariffs used to prevent ability to import under the local cost of capital at a ration exceeding that of the difference in global capital cost. With WTO-imposed limits on tariffs, inflation prevention becomes impossible via interest rates when import costs become lower than the cost to borrow in your country.

Two net effects: a) this causes local problems to by necessity become global ones; b) it limits the ability of poorer countries to ever gain a relative foothold - they will always be low-cost producers for the G-8.

2008 Sep 05 06:05 PM

[investor88:]

From what iThinkBig has posted above, it seems things are pretty bad out there. He says consumer has no way to run or hide... A recent article in SeekingAlpha says we are now in a 16 year secular bear market that started in year 2000. Looks like we can hope for the best but must be prepared for the worst!

2008 Sep 06 10:58 AM

[Anne-Marie:]

To your last point, Investor88, I believe that really was the intent of Brett's article...prepare and be alert to the movements of the market, day by day, and week by week. We can stand and talk on either side of these opposing thoughts until we are blue in the face. All that does is take our breath and spin us up. It doesn't make our financial holdings larger, so as traders, rather than analysts (who are usually behind the curve), we read, we watch, and we prepare to act in the direction that presents itself, rather than predict.

When we stand on one side of a position too vehemently, our minds become closed to signals that point in other directions because we all desperately want to be right. In the market, filtering information is a dangerous thing, yet we do it all the time, and most often it is the reason we lose money.

2008 Sep 07 04:50 PM