The Stock Market Becomes Sneaky

What was notable about trading in the stock market on Thursday was the market's utter inability to muster a bounce after the big sell-off on Wednesday. There was a feeble attempt at a rebound in the first 20 minutes of trading, followed by a mild decline, then a sideways move in a tight range, another mild lurch lower, another feeble bounce attempt, more sideways trading…and then the day's losses more or less doubled in the final 20 minutes.

That is of course rarely a good sign. Most of the day actually felt rather boring, and when the small rebound from the mid day lows began to take shape,  most observers probably thought that the market was about to come back after a small sell-off clearing out a few residual margin calls. The slide at the close was likely a nasty surprise, and although the overall price damage was much milder than on Wednesday, the psychological damage may actually have been greater.

Below is a two day, 5-minute chart of the DJIA illustrating the action:



The last two days in the DJIA, 5 minute candles – click for better resolution.



The Big Picture

We have documented the growing danger to the stock market since early September, mainly based on technical evidence. There was little need to point out the deteriorating fundamental backdrop when discussing the market, as it was anyway clear that stocks were solely levitating on the fumes of monetary pumping. Economic fundamentals were increasingly suspect in any event, given Europe's recession, China's slowdown and the growing mountain of evidence showing slowdowns and/or contractions elsewhere in the world. As we never tire to point out, 'decoupling' theories have little merit in today's interdependent world.

Readers may want to briefly look at these earlier posts, such as “Breakout or Headfake”, published one week before the peak in the SPX to date, where we discussed the market's tendency to produce breakouts in recent years that  quickly fail. A growing number of divergences was strongly hinting that another failure was likely.

Then we discussed the astonishing extremes in a number of positioning and sentiment indicators that were in evidence as of early October, with a bit of context provided by ruminations on bonds, the economy and 'QE3'.

In late October we went over the growing number of technical breakdowns in high beta momentum stocks and the weakness in capital goods producers.

Since then we have focused mainly on sentiment indicators and shown that they have continued to provide plenty of reasons for concern. We are going over all this ground again to bring the bigger picture that has emerged over recent months into relief.

It should perhaps also be mentioned that throughout this time, net insider selling has been uncommonly high. It appears as though a multi-month distribution process has taken place. If so, then we can of course not be certain that it is actually over. The current sell-off may lead to yet another rebound phase; this is not knowable at this point, especially as the 'QE' funds are soon going to flow (the first settlements are expected by mid November).


The Near Term Situation

However, to switch gears and return to the near term action, we want to remind readers of something we have frequently mentioned in the context of corrections. Although one never knows in advance how big or long-lasting a move lower will be, one can try to gauge the situation by observing in real time how traders react. Do they become bearish very quickly? Or are they inclined to try to catch the proverbial falling knives?

This is now where the above observation about the market's 'sneakiness' is potentially important. Normally, sentiment tends to follow prices fairly quickly. However, when there is a very big down day out of the blue (such as on Wednesday) and on the next trading day half of the day's losses occur in the final few minutes of trading, there is simply not enough time for bearish sentiment to become entrenched. The bears remain timid, because they fear the market to be oversold, while for the bulls it is all going too fast.

And we see this in indicators such as the put-call ratios. They are higher than they used to be, but there are still no extreme readings. In fact, our sentiment indicators are all still in territory that says this down move is highly unlikely to be finished yet. An intervening bounce would probably do nothing to alter this assessment, on the contrary, it would likely solidify it.


Strange Inter-Market Happenings

We always watch the market action during the day very carefully. 'Market action' meaning, 'action in all, or most markets', not just the stock market. Sometimes there is a disturbance in the force so to speak, and something unusual happens. Unusual that is, relative to recent times. What stood out over the past two days was the fact that gold suddenly decoupled from the SPX, after having closely correlated with it previously.



The S&P 500 and GLD over the past two trading days – they are suddenly diverging – click for better resolution.




Unfortunately we can not offer a straightforward interpretation of this development. It could be that gold is beginning to discount a coming flood of excess liquidity; in that case its rally may be a harbinger of an upward reversal in stocks in the not-too-distant future. Note in this context that the SPX's recent break below the 200 day moving average may embolden those who have just 'learned' in June that such a break is an invitation to buy the dip:


Will the break of the 200 dma invite dip buying again? We have some doubts … – click for better resolution.



There are a number of differences between then and now however. One is the aforementioned lack of time for bearish sentiment to sufficiently grow this time around. Another is the technical condition of the high beta leaders as exemplified by the NDX – which last time held its 200 day ma, but this time simply broke through it with a gap and has become the downside leader among the major indexes:



The behavior of the NDX is clearly different this time – click for better resolution.



We must therefore think about what else gold's sudden decoupling could mean. If money is moving into gold because of its 'safe haven' role, then we are possibly looking at a situation akin to June-November 2011, when the flaring up of the euro crisis had a similar effect. But what could be the problem? It is after all quite noteworthy that the stock market's sudden sharp decline seems to have no clearly discernible trigger.


Gray and Black Swans

On Wednesday we briefly mentioned (in the final paragraph of the article on Tom McClellan's obscure euro dollar indicator) that it is often a good idea to consider potential 'left-of-field' events that could suddenly upset the markets. We pointed out that there are e.g. 'gray swans' that consist of problems that have long been known, but have been filed away as 'not likely to impact us anytime soon' by most observers.

In an example of synchronicity, we came across a guest post by Sober Look's Walter Kurtz at Also Sprach Analyst on Thursday,  in which he discusses 'tail risks'. He points out that the so-called 'fiscal cliff' is the risk that is foremost on everybody's mind, closely followed by the euro area debt crisis (this is according to a well-known Merrill Lynch survey of fund managers).

He concludes that one should therefore look for tail risk elsewhere, as these are essentially 'watched pots' (as an aside, it is noteworthy what worries the fund managers participating in the survey least: municipal defaults and 'other'; take a look at the blow-off like move in MUB in this context).


If the stock market just kept plunging for no obvious 'reason', then we would have a true 'black swan' event on our hands – the plunge itself would be the 'swan' in this case (this is what happened more or less in 1987 – if one asks people about the event, one soon realizes that the crash had a great many suspected triggers, which is the same as saying none in particular). However, it might also be that the reason only becomes obvious with a lag, and that it turns out to be an entirely unexpected development – then that event would be the 'black swan'.

However, the market would nevertheless sense the approach of such an event in advance, simply because information is not uniformly distributed among market participants. Some have better and more timely insights that others and will act before something becomes widely known. This is why we pay attention when unusual divergences begin to show up, such as a sudden breakdown in recently well-established correlations.



The municipal bond ETF MUB – no wonder municipal defaults are the least of the worries of fund mangers at present. However, this is beginning to look like a dangerous blow-off, complete with a classic RSI divergence – click for better resolution.



Mixed signals – a number of features of the US economy at a glance, via the WSJ. Not much to write home about, but also nothing that seems overly concerning (assuming that the 'watched pot' fiscal cliff is no problem) – click for better resolution.



The good news for the market is that tech leader AAPL has gone down for seven weeks in a row and has just hit lateral support as well as the lower weekly Bollinger Band. This should actually be a good point for a rebound in the stock to begin – click for better resolution.




Addendum: Regime Uncertainty

It should be briefly mentioned that the outcome of the election means that 'regime uncertainty' continues. This article is not the place to discuss the subject in depth, but clearly the uncertainty about future regulations and taxation will continue to impede investment, hiring , etc. and thus remain a drag on the economy. 





Charts by: stockcharts, bigcharts, WSJ



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7 Responses to “Something Wicked This Way Comes?”

  • RedQueenRace:

    “One note: I think that the administration expects, and wants, employers to shift employees to the exchanges and away from employer provided healthcare as this will encourage the de facto development of single payer (government) health care by stealth.”

    I don’t think it will be by stealth. I think the system is designed to fail so that the people demand the government take it over. It will be touted as another example “free market failure.”

  • RedQueenRace:

    This sell-off has been interesting to watch as the VIX (similar to watching put/call) is not spiking. The SPX slid to the 200 DMA with little fear exhibited. Yesterday the VIX was largely between 18.25 to 18.50 even while the market slid into the close.

    Overnight the ES traded down to 1363.50. With the premium at -3.63, at its bottom the ES was trading at an SPX-equivalent 3 standard deviations below the SPX 50 DMA. Unless the market was going to crash a big bounce was likely and we got one.

    ES overnight bottoms that do not get tested during the regular full session are suspect. Far more often than not (but not always, of course) they eventually get re-tested. But a significant rally to relieve oversold conditions (and chase out weak shorts) can occur first.

    There is still over an hour to go so it will be interesting to see how today’s action settles out. If the market sells off late and closes near the 200 DMA the direction early next week is unpredictable. If it goes out near the highs the odds favor the rally continuing after early gyrations are taken care of and I would look for a push to SPX 1400 at a minimum.

  • Floyd:

    The fiscal cliff is a double headed white swan.
    White as we know about it well in advance.
    Double headed as know option is good [at least in the short term].

    Kicking the can has its limits.
    Ignoring the debt and deficits has immediate consequences (depressing growth, weakening society due to misallocation of capital and theft through inflation).

    Addressing the debtberg is like withdrawal from addiction.
    Merely balancing the budget, not to mention paying all debts and obligations, is a drastic shift from the dominant pathways of the US economy during the past 40 years or so.
    Such a change must send shock waves through the whole system (most of the world).

    I’ll be genuinely surprised if we see this solved in our life time.
    It is not in the best interest of those in position of influence as it will reduce their loot.
    It is far more realistic that the administration framework will be bent and molded to further sustain the system without truly fixing it.

    Reminds me the decline of Rome.
    Are we going to mimic it?

    • JasonEmery:

      I’m sympathetic to your argument, Floyd. However, basically, you seem to be implying that if we stop right now, we can fix this mess. I don’t see how a $15 trillion economy, that is over half govt. and financial services, and therefore only $7 trillion worth of actual goods and services, can pay down the $50 trillion in credit market debt we have run up (public and private). Then there is the additional burden of $100 trillion in unfiunded liabilities!!

      I think Bernanke realizes this and there is no down side to kicking the can down the road. If he can make it to the exit door before the house of cards crashes, he’ll be no worse off than Greenspan, who 90% of the morons think is a genius.

      Regarding health care, they make you answer a million questions and take a blood and ekg test before they will insure your life. Why not the same for health insurance? We’re all being held hostage by the dopers, cigarette smokers, fat slobs, etc.

  • GaryP:

    I see Obamacare as the biggest headwind for the economy. If employment, especially full time employment decreases (or doesn’t grow significantly-we need 125,000 full time jobs a month to stay even), the economy has to shrink. If health care takes a bigger portion of the economy, as it will under Obamacare, despite claims to the contrary, other sectors will have to shrink unless there is income growth (which there won’t be with such a weak job market). What I expect, is to see a mass conversion of full to part time work (already started) and a demand by employers for full time workers to do more because the costs of health care will preclude hiring more workers.

    We are already seeing a lurch toward part-time employment as major companies act to prevent their low wage employees becoming anvils around their neck as they struggle in a bad economy to keep their head above water.

    My simplistic analysis is this:
    Assume a minimum wage employee is now economically justified. It cost about $15,000 a year in salary plus what ever regulatory, tax and benefits costs add to the mix. Say about $3000 per year for unemployment, workers comp, SS, and a few benefits (no or minimal healthcare, like McDonalds). TOTAL: $18,000.

    To keep this person full time under Obamacare, you must pay a $2K fine or provide a top end health care package. The cost of the health care package (assuming a family of four goes with the employee) is $12K-$15K.

    So the employee, that last year the employer thought was worth $18K, now cost $20K (including the fine) or up to $33K.

    For low margin businesses (like groceries and restaurants) that hire a lot of low wage employees, a 10% increase in employee costs (if they pay the fine-a simplistic estimate, but bear with me) probably about consumes their entire profit margin. How about a 80% increase in employee cost (if they provide the health care). Can’t be done.

    Therefore, the employer has to protect themselves by switching full time employees to part-time and keeping part timers below 30 hours (the Obamacare definition of part time).

    This is already being done by Kroger and the Darden Restaurant Group. These are big employers and if they need to do it how about the small businesses that are barely surviving in this economy-assuming they have 50 or more employees, or would like to grow above 50 employees.

    Add in the need to stay competitive with McDonalds (for example), that has been granted a waiver from Obamacare, giving it a competitive advantage due to its political clout, (How many small businesses will get an Obamacare waiver) and either you must pay the politicians for a waiver, cut your employees hours or go under.

    Obamacare will depress consumer spending, especially in young, healthy people that would not choose to spend their incomes on health care but are forced to (either directly or indirectly through employers decisions).

    The cost of employees will be increased, sometimes dramatically, and that has to suppress employment (if you know anything about business).

    The cost of the federal exchanges will drive up the deficit, worsen the fiscal cliff and hasten the downgrading of US debt, which will damage the business climate in the US and drive up imported goods as the dollar weakens.

    One note: I think that the administration expects, and wants, employers to shift employees to the exchanges and away from employer provided healthcare as this will encourage the de facto development of single payer (government) health care by stealth.

    • zerobs:

      One note: I think that the administration expects, and wants, employers to shift employees to the exchanges and away from employer provided healthcare as this will encourage the de facto development of single payer (government) health care by stealth.

      While I think this is true, there will ALWAYS be a higher-order health care system that knows the only thing worse than dealing with getting paid by insurance companies is being paid by government. It’ll wind up like Illinois – a single, always-tardy-always-short payer.

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