A Dip Is Fast Approaching

Includes: IWM, MDY, QQQ, SPY
by: Paulo Santos

Quite simply, we're about to have a dip in the market. It will probably happen during this very week. Several indicators - which I will disclose in this article - are at extremes which leave little doubt regarding this conclusion.

In my article "Playing With Money Printing Rules" I said that the fiscal cliff getting nearer and excessive sentiment were clues to approaching volatility. I also said that any 3-5% dip ought to be bought given that the Fed is printing nonstop at a rate of $1 trillion per year. Although I still believe that the first dip will be bought, I now have reason to believe that the risk in buying it is higher than I previously anticipated.

So what are the clues towards this impending dip?

New highs

NYSE new highs are clearly braving new ground. The 10 day moving average charted below is clearly at a blow-off extreme. Such a condition is conductive to a near-term dip.

Margin debt

This is perhaps the most worrisome of signals. But it is also the one with the most in-built delay. As of November 2012, which is what we got, margin debt was already close to $327 billion, a value surpassed only during the credit bubble back in 2007. In December and January this value probably expanded further, putting us into bubble territory (Source: NYSE).

Margin debt makes buying any dip a danger. Apple's (NASDAQ:AAPL) fall from grace was probably already at least in part due to margin liquidation. But given the overall level, it's likely that Apple was not the only stock which first benefited, and now might be punished, because of margin liquidation.

Without the margin debt situation, any 3%-5% dip in the market would have to be bought. As it stands, even though the first dip will likely be bought, the danger is that we might fall into a self-perpetuating liquidation leading to a larger than normal dip.

Overbought nature

The 5-day RSI is a reasonable indicator of overbought and oversold conditions. We can see that the S&P500 and S&P400 are at levels consistent with at least a near-term small dip. Be mindful that this signals just a 1-2 day dip, nothing more, though.


Several sentiment surveys, from the BAML fund manager survey to the AAII sentiment survey, are pointing to extreme optimistic sentiment. Timing tops due to excessive sentiment is less reliable than timing bottoms, but sentiment is clearly consistent with a possible dip at the levels we stand. The chart below relates S&P to AAII sentiment at the present levels. Sentiment by itself would not be enough to call the dip, because AAII excessive sentiment has already failed in the past when put against money printing.

(it's not apparent in the chart, but the ratio of bulls/(bulls+bears) has reached 0.68, thus within a range which usually warrants caution.)

AAII sentiment is usually more accurate when timing buys. In the chart above we can see how excessive sentiment has failed to signal a near-term dip during late 2010 and early 2012. In both these instances we had money printing (2010 was QE2, Fed; 2012 was LTRO, ECB). Very minor dips happened around the excessive sentiment, however. Although somewhat fallible, excessive sentiment was a better sell signal before the monetary madness.


Given the levels at which sentiment, new highs and margin debt are, it all points towards a near-term dip in the markets, namely the S&P500 (NYSEARCA:SPY). Mid caps as measured by the S&P400 (NYSEARCA:MDY) and small caps as measured by the Russell 2000 (NYSEARCA:IWM) are also incredibly overbought and should participate or even lead the dip.

The margin debt levels increase the risk that this might be a medium-term top and not just a small dip. Although after huge rallies the first dip tends to be bought, there's a chance that a larger slide might follow. This is counter-acted by the endless money printing, and we don't have an historical precedent for when money-printing collides with excessive margin debt, so the ultimate result cannot easily be predicted.

A final thought. It's likely that during this dip the Nasdaq 100 (NASDAQ:QQQ) will outperform the S&P500, S&P400 and Russell 2000. This should happen because it's likely that Apple will stop bleeding and thus provide some support even as other stocks see selling pressure.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.