From Sleepy to Hyperactive

Tasmanian Devil Cartoon

The US equity markets have been very sleepy for the last 4 to 6 months moving sideways within a trading range. One day up. One day down. Essentially going nowhere causing investors to become very complacent. That all changed over the last two weeks when the S&P 500 moved lower by over 11% in less than six trading days. This caused the volatility index (VIX) to spike by over a 100%. Even know we are well off the lows, the wild swings continue in both directions keeping volatility at elevated levels as you can see in the chart below.

 

(Click on chart to enlarge)

CBOE Volatility Index

 

I'm going to save time and not regurgitate headlines about China, Oil, Greece, the Fed and interest rates. If you want to hear those stories spun a million different ways just turn on BNN or CNBC. Let's take a step back and take a look at the bigger picture.

 

The SPY, DIA and the QQQ have all traded at ALL TIME highs within the last 12 months. Since those highs the above mentioned ETFs have sold off approximately -9%, -11% and -9%. This doesn't seem all that bad but the the bulk of that sell off happened over three days of trading. Since then we've had a significant rally off those lows. What if it took a month or a couple weeks to do the same damage? Do you think the headlines would be the same? Do you think the feeling of panic would exist? I think not. Healthy markets often have 10% plus corrections quite often but usually not this fast. Bear markets are usually defined as a 20% sell off. We aren't there yet but we're getting close.

 

The daily charts look hideous and there is no disputing that but if we take a longer term outlook things don't look quite as scary. Lets take a look at the weekly charts to see how things are playing out.

 

(Click on charts to enlarge)

SPY
DIA
QQQ

 

A lot of technical damage has been done and it's never fun to experience such a quick and nasty sell off. However, the long persistent uptrend displayed in the charts above show that we were well over due for a correction. Corrections or sell offs are healthy for markets as they shake out the weak hands and allow fresh money to be put to work. Having said that it's impossible to know how much further the Indexes will fall.


I know I sound like a broken record but it's best not to try and catch a falling knife. If you're looking to put fresh capital to work I'd wait and watch for calmer price action and less volatility. The current sell off is a good reminder that having a cash position is not to be underrated as corrections are hard to predict but they will inevitably occur.