Does the stock market deserve to go down? Has it gone down too much? much? Are these even appropriate questions to ask? Are they behind why the stock market's become so volatile and the selloffs so brutal?
We have to ask because when the market plummets more than 1,000 points as it did yesterday and then vacillates 1,000 points as it did today, and the global bourses lose $4 trillion in 8 days and the VIX, or fear index, skyrockets to 50, the highest since 2016 it's time to figure out what's gone wrong for the bulls or for the market itself. Let's unpack both and try to make sense of things.
First, as we said last night, the market was due. We advised people here to sell last week at this time and told club members of actionalertsplus.com to lighten up because bulls make money bears make money and pigs get slaughtered. When you have a move that borders on the parabolic, meaning it goes up pretty much in a straight line, that's a market that is ripe for a fall even if you can't see one coming. Isn't that, after all, the nature of the beast? So you have to prepare as if it is going to happen so you have cash to put to work in better stocks as they fall. You upgrade your portfolio and you avoid some losses that you must do if you are going to be a good investor. Now, mind you, nobody says you have to take action. Nobody says you even have to trade, ever, especially if you are investing far enough in the future that it might not matter.
But I think that if losses can be avoided simply because you are being a pig, it is vital to trim some of your most profitable positions.
So, point one, I think that just as I would say if we were going down every day that it might be time to pick up stocks, it is right to take something off the table. They are mirror images of each other. We managed to dodge some ten percent declines by selling one week ago.
Point two: we ended up with some pretty good reasons to do some selling. Yields soared on a strong employment report. When interest rates go up dramatically even if it is just because they are off a low base, investors are less inclined to take risk, and stocks are risky, and more inclined to be risk averse, and nothing is more risk averse than buying treasurys.
Plus, rates are going higher in large part because of fear of inflation and if you get a return of inflation, whether it's wage inflation or commodity inflation it makes large institutional investors be less willing to pay up for stocks. That's known as a shrinking p-e, where the price to earnings ratio falls. That's what's been happening now and given that stocks had soared to levels where there were lots of questionable valuations, the direction of the sell-off makes tons of sense. It's why the utilities are going down -- they are more dangerous than owning bonds. It's why the drug stocks are being hit particularly hard because their values are heavily correlated with future drug approvals and their yields, after the amazing runs we have had, don't offer much protection here.
But how about the velocity of the sell-off? That, I think, turns out to be directly related to some instruments that really put a lot of pressure on stocks and accelerated whatever decline we could expect from the new inputs I just described.
If you really want to get into the nitty gritty, a small exchange traded product that allows people to short the VIX, the Velocityshares inverse VIX short-term stock (XIV) , went bust putting immense pressure on the stock market itself. Now I have often railed against these products that often are the tail that wags the dog. Many a hedge fund manager, taking advantage of what seems like the end of volatility -- remember how placid this market has been -- borrowed money to own this XIV as it is known and when volatility spiked this piece of paper got crushed dropping from 100 to 8 in a single day. These instruments are reckless in their creation and should not be allowed. The owners of these pieces of papers got wiped out and, as a corollary had to sell the S&P 500 futures which was the proximate cause of the gigantic midday decline yesterday and the 560 point sell-off in the Dow at the opening. I was out there telling you it was phony and to buy and I hope you didn't.
Now though, we have to recognize that the same reasons the market sold off last week still exist but that silly inverse vix product has been entirely wiped out taking the gunslingers out with them.
Sure, we know that lower corporate taxes and repatriation of assets from overseas that can be used to buy back stock, had to be baked into stocks. And the fundamentals are terrific. But the cake got overbaked and that's as good analogy that I can find to explain the selloff and the exchange traded product is what accelerated the decline.
So how about now? Have we hit bottom? I think that some stocks are trying to find their footing namely the techs aided by a terrific quarter from communications semiconductor giant Skyworks Solutions (SWKS) and a guide-up by commodity chip maker Micron (MU) . But other stocks, notably the food and drug contingent are still being singed because they tend to get hurt hardest after utilities as their yields can't protect them and they do tend to lag when inflation rages.
But, there is something out there that tells me we could be closer to a bottom than people realize: the S&P's proprietary oscillator which measures buying and selling pressure in the form of over bought and over sold statistics. Yesterday we hit a down 6.8 reading. Any minus reading can be a sign that the downside is overdone. Minus 6.8 is real over done. If we look at the history of the last three years we only have five periods where we got this low and four out of five were fantastic buying opportunities.
Let's go over them so you know what I mean. The first comparable negative reading came in late August of 2015 when investors dumped stocks because of fears about a collapse in China. Stocks jumped 9.1% in the ensuing two weeks as those worries subsided.
Or how about the January 2016 beating because of a vicious decline in oil, down to $26 a barrel? Two weeks later we rallied 9.7% as oil regained some altitude. We had a similar situation in February of 2016 when oil re-touched $26 and the banks that lent to the oil companies revealed some potentially large losses. Two weeks later, with oil stabilizing we rallied 17.7%.
Finally before President Trump was elected we got walloped. Two weeks later with a Trump victory secured, the market rallied 7.2%.
The only time we got THIS oversold and we didn't rally two weeks later was in December of 2015 when we feared a government shutdown. The House solved the issue and we rallied 1.4% that next week but then we fell 3.6% a week later.
I know these are just totems and judging by the action today we could be even more oversold by tomorrow, but I will point out that I have NO BETTER indicator than what I just gave you, other than the news truck gauge. That's where I see local broadcast affiliates with satellite trucks parked at the intersection of Wall and Broad. We had those in spades today.
So here's my bottom line: I know that the parabolic move to the upside is over and we now have real issues involving inflation and the attractiveness of U.S. treasurys. But I also know that the decline was exacerbated by an instrument that blew up which spilled into the S&P 500 at the opening. That said when you see the panic trucks and you consider the S&P oscillator readings, it's time to buy, not sell, and this weakness must be used to put some money to work, especially if you have a contribution for retirement purposes or simply have some sidelined Mad Money that's been patiently waiting to go into stocks that are down on their luck of companies that are doing incredibly well and are now begging for investment.