The market action since Thanksgiving has been amazing, and there is a lot to cover after the past week, so let's get right to it.
The last five days brought the worst price action the U.S. market has seen for a few years. The Dow Jones Industrial Average, for instance, dropped nearly 800 points from the high it set Monday morning. The S&P 500 fell a staggering 3.7% off of an all-time high, and the Russell 2000 slid as well -- though by not nearly as much.
We can point to one culprit for the poor action: crude oil. Since Thanksgiving, crude prices have cascaded downward, reaching five-year lows -- and, unless some intervention occurs, it appears the slide could continue. This past week, the oil drop came to some 12%.
We have seen many try to catch this falling knife, but with oil volatility so high -- see the CBOE Crude Oil Volatility Index (OVX) chart above -- it makes little sense to try and call a bottom. For one thing, with volatility at these high levels, option prices are juiced up. As a result, there is no advantage to buying. Selling premium is normally a great strategy amid a volatility spike, but you wouldn't be cleared to do that the price has surely bottomed.
Turning back to the market itself, the CBOE Volatility Index (VIX) has moved up nearly 100% over the past five days, and this action is what has caused major concern among market players. The previous Friday saw the VIX clocking in under 12%, at or near the lows of the year. That's a dangerously complacent level -- and I've spoken about that here.
Recent spikes in the VIX have been great areas for reversals when they've happened, and not before, but this time around everyone buying protection is getting on board early, looking to cash in on the big spikes lower. This is a change in the protection-buying pattern we've seen before -- a shift that usually seems to occur at the end of a big run. We'll have to see if a spike high occurs quickly this time around.
One of the most reliable tools for spotting an impending reversal has been the ratio between the VIX -- which reflects the market's expectations for the next 30 days of volatility, based on option-buying -- and the CBOE Three-Month Volatility Index (VXV), which covers the following 90 days. In a bull market, this ratio is not sustainable above 1 for long. As my friend Steven Place of Investing With Options says, it is the place to "buy the blood" (see chart below). We chatted about this in mid-October when the ratio spiked above 1, and while the condition lasted for about five days, it triggered a very powerful S&P 500 run -- more than 190 handles up!
Overall, I would say the odds favor a turn higher in the markets in the next couple of days. We'll play it that way.
The VIX term structure is something I watch closely, and my friend Jay Wolberg has some great charts and statistics each day on Trading Volatility. Currently, the VIX is above the levels of where many of the futures are, as the reach for protection is extremely short term in nature. However, the curve has flattened significantly, much as it did in mid-October, when the term structure actually inverted for several days. Yet that proved to be a temporary condition: The curve soon after "normalized" and metamorphosed back to a bullish construct. So I suspect the worry will be short-lived this time around, as well.
Market breadth has been another worry of late. Thanks to the extent of selling action, and the shock from dropping crude, those holding long positions on stocks have been forced to sell, and are getting out of the way -- as we saw occur late Friday.
Buyers have stepped aside, too. The McClellan Oscillators are well oversold: That for the NYSE came in Friday at a ridiculously low minus 201, while the Nasdaq's clocked in at negative 96. These are extreme-oversold readings.
Against this backdrop, next week is set to bring a big convergence of data and events that may swing the markets. We also are entering a seasonally strong period for stocks -- and, while that has not been the case for far this month, we could see the tide turn with all of the bearish sentiment stacked high. The Federal Reserve will have its last meeting of 2014, and I suspect it will implement no change in interest rates for U.S. Treasury bonds. It will, however, bring us a revised forecast, and Fed Chair Janet Yellen will hold a press conference.
Otherwise, a slew of important economic data is forthcoming, and key earnings reports are set for release by Nike (NKE), Oracle (ORCL), FedEx (FDX), Accenture (ACN), General Mills (GIS) and CarMax (KMX), among others. This is also a big options-expiration week, and that'll have a major effect on price action as the week finishes out.
The speed of these declines is fomenting worry, doubt and uneasiness. Still, we'll reiterate what we've been saying for a while now: The market is need of a bigger correction, but we won't make the timing call. Why is that? Simply put, the market will "see" the reason for a correction, and perhaps a bear market, and will tell us about it before it happens. The stock market is a great discounting mechanism that never fails, so there is really no sense in trying to front-run a move.
Santa Claus tends to come to town with a rally on Dec 24, and that generally lasts until Jan. 5. We'll have to see if he's bringing presents to Wall Street this year -- or lumps of coal.