It is extremely rare for a market to go down for 13 trading days without a real bounce as this one has done. Last year we went down for 13 days without much of a bounce, which culminated in a huge plunge after the US was downgrade by S&P. Previously this was an extremely rare occurrence. Stuffing $18 billion worth of Facebook shares into a very weak market did not help matters. This decline continuing much longer would have very few precedents. Have a great weekend.
The short term indicators are at an extreme and should produce a bounce very soon. Even within the framework of a momentum market that I laid out yesterday this move is very extreme. The level of oversold and the put/call ratios are approaching the extremes seen the last two Summers, which ultimately led to strong bounces. I expect the current situation to resolve in the same manner.
There are some intermediate term indicators that are still not in place. This might mean we will have to come down again to get a better low after a rally. Rydex traders are too long, the Investors Intelligence survey is not at an extreme and I’m just not seeing the type of negativity one would expect after such a large drop.
In the past couple of years the market has been exhibiting huge moves both up and down without any corrective moves in between. Last year the S&P 500 fell 250 points in a three week period pretty much in a straight line. From late November through March the S&P 500 climbed relentlessly without a correction. Most recently the S&P 500 has fallen over 90 points in a little over 2 weeks. These types of moves used to be extremely rare but now happen on a regular basis. Hedge funds are to blame.
Years ago mutual funds dominated the investment landscape. While they are still larger than hedge funds they don’t make large changes to their equity allocations. If mutual funds as a group move their equity allocation by 1% that is considered a huge move. Hedge funds can move from risk on to risk off in a matter of weeks and they tend to herd. Last Summer they went risk off in tandem and early this year they went risk on in tandem. Hedge funds are the marginal buyer and seller.
Regardless of the reason this is the new reality we are in. This means ensuring one can withstand the persistent moves in either direction. While I feel that this move lower is on borrowed time I am doing little because my portfolio is taking a hit due to individual positions performing poorly. I want to ensure that if we do see something worse I can make it through it.
We are now maximum oversold as we will be dropping large negative numbers from the 10 day moving average of the NYSE Advance-Decline Line.
The CBOE 10 day moving average is now comfortably in territory only seen the past two Summers as well.
Hopefully this will be enough to stop the pain. Have a good night.
The market is extremely oversold as the chart below shows. The last time the market was more oversold was in August when S&P downgraded the US credit rating. We will be dropping negative readings for 8 out of the next 10 days and 5 out of the next 6. We are dropping a small negative reading today so its possible for us to get a little more oversold but this is extreme.
Facebook has raised its IPO size and its now possible it will be over $18 billion. That is a huge cash drain on the market and it is possible that this has been contributing to the weakness.
The chart below is the 10 day moving average of the NYSE Advance-Decline line, which is showing an oversold market. It is possible for this line to go lower today and tomorrow but after that it becomes very difficult. This has to do with the numbers that are being dropped from the 10 day moving average.
The chart below is the 10 day moving average of the CBOE put/call ratio. It is showing the most put activity since early December. It will have a difficult time going much higher starting tomorrow.
Many signs are pointing to an oversold market and this should lead to a rally. Unfortunately, there are also some troubling signs such as expanding new 52 week lows and sentiment indicators that have not reached intermediate term extremes. That likely means that the rally will have a difficult time travelling too far and that we are likely to need to retest these levels again after a rally.
I received quite a surprise when I opened my computer this morning. Aside from Europe collapsing again I was hit with a big downgrade on a large position of mine. Goldman Sachs downgraded Symantec from hold to conviction sell and put it on their conviction sell list with a $14 price target.
I do not fool myself into thinking that Symantec does not have issues. As a matter of fact I know they have issues and there are a couple of business lines that make me cringe. The reason I own Symantec is because at six times free cash flow I believe their issues are baked into the cake, and the cake is still cheap.
What struck me about the downgrade was that the analyst predicted that free cash flow could fall to $1 billion dollars or a decline of 35%. I assumed that free cash flow had the potential to decline. With a 16% free cash flow yield there is still a margin of safety if free cash flow declines. But I did not think free cash would fall by that magnitude.
I looked at the assumptions that the Goldman analyst put into his Symantec model. He is predicting lower than expected sales and a large decline in margins but that was not enough to get free cash flow all the way down to $1 billion. That only reduced free cash flow to the $1.3 billion area. In order to get to $1 billion in free cash flow he had to lower his depreciation and amortization assumption and raise his capex assumption among other tweaks of his model. These new assumptions were way off what the rest of Wall Street had modeled in. It became clear to me that the Goldman analyst was torturing his spreadsheet in order to get it to a $14 price target. I suspect that he pulled these numbers from where the sun don’t shine. I have had very good results in the past when stocks I owned went on the Goldman Sachs conviction sell list. I expect Symantec to be no different.
I have been discussing the upcoming oversold reading a lot. The put/call ratios will also be oversold early this week. The chart below is the 10 day moving average of the ISE equity-only
It is showing the largest amount of put buying we have seen years. I don’t believe that sentiment is nearly as negative as this chart would make you believe but the message is clear. In a day or two if we see continued put buying the the 10 day moving average of the CBOE put/call will also be in the area of excessive pessimism.
As an aside I wonder if weekly options are having an effect on this ratio.
I have been highlighting how the market is close to becoming maximum oversold. That remains the case and I would expect that if we go down at the beginning of this week we will be very oversold and poised for a rally at minimum. However, an argument can be made that we are not yet at an intermediate term low.
Once or twice a year sentiment indicators typically reach an intermediate term extreme in negativity. After a rally that had stretched for six months its possible that we are headed for such an extreme. While sentiment is negative it is not at what I would characterize as at an intermediate term extreme.
The most troubling indicators for the bulls are the Investors Intelligence bears and Rydex traders. Investment Intelligence bears are at a very low reading of 20%, a reading typically seen at highs. The bulls are at 39% which is low as well. The reason both bears and bulls are low is because most investors are in the correction camp. Overall, I would characterize the Investors Intelligence numbers as neutral to slightly bullish but not at the type of extreme seen at good lows. Rydex traders have 4.5 times as much money in bullish funds as in bearish funds. There is no way to paint that as anything but bearish.
Overall the indicators are pointing to bearish investors and a market that is becoming oversold. This is a big positive change from what we saw at the end of March when investors were excessively bullish. But it is not yet enough to be confident that we are at an intermediate term low.
The market is at a pretty good oversold reading but has the potential to get a little more oversold early next week. Sentiment is very negative but not anywhere near the type of extreme we saw this Fall. If the bears give this market one more push lower early next week it will likely be buyable. Have a great weekend.
