Reviewing Monday's Carnage

Monday’s jarring market woke everyone up from the snooze fest we’ve had to endure recently. The 500+ point drop reminded those who were around then, of the 1987 crash. But of course, there was a world of difference between the two Mondays. Today’s bounce is, believe it or not, the normal thing for the market to do when it has undergone a large gap down.

Whites Of Their Eyes
Finally we saw some fear in the market as the CBOE Equity only put call ratio reached above 1.18 - that’s high but not near as high as it could potentially go. Tuesday it pulled back once again below parity (at 0.93). But honestly, no one is convinced until they see this and other fear gauges spike into the blue yonder and higher, and then remain there for two, three or more days.

Lasting bottoms are carved out of pain and a total collapse of confidence. Although the news headlines are very pessimistic and one would almost be forgiven to jump into “contrarian” mode, the sentiment gauges don’t quite show the definitive panic that must precede an inflection point. For example, according to the Hulbert Newsletter Sentiment Index, the average newsletter editor is more bullish now than at the low in July. This, even though after Monday’s close the market was lower.

The volatility indices, VIX and VXN did spike higher but again, last summer and just a few months ago in January 2008, they got as high at 37.50 - so we are close, but still not high enough.

Devastating Breadth
Taking a quick look at the market internals, there were only 36 advancing issues on the NYSE and only 390 on the NASDAQ. The declining issues dwarfed them at 2,921 and 2549 for the NYSE and NASDAQ respectively. Trading volume was so lopsided that for each advancing share there was 172 declining shares. I haven’t done the calculation to see but it looks like a same assumption that Monday was a classic Lowry’s 90/90 day to the downside.

Technical Damage
There was serious technical damage all over the place. Not the least of which was, as mentioned before, the close below the July low. But what worries me, is that although there was damage done, it doesn’t show up as extreme on the charts as the screaming headlines would have you believe. For the most part the market is still approaching a final exhaustion. Where I would feel comfortable saying that there has been a washout of selling.

And yes, this is exactly the sort of thing that happens at the worst of times, when we are close to a major bottom. But I’m not convinced we are there yet. We are close, but before we get there we’ll see more volatility.

Take a look at the percentage of stocks trading above their 10 day moving average. Even after Monday’s decline, there were 17% above this short term moving average. For a lasting bottom, I’d like to see below 10% and preferably below 5%. Or take a look at the high low ratio:

Probably the most important thing to take away is that while heavy selling is a necessary part of an change in trend, by itself it doesn’t guarantee anything. But if heavy selling is followed closely by intense and almost indiscriminate buying, then chances are it is the real deal.