Yesterday’s late day collapse was a little concerning to say the least…..As of 2pm I really thought the market was trying to get some legs and make move to close up on the day, which in a lot of ways would have been very impressive and maybe a little signal of a short term bottom. The fact that we just gave up at the end of the day and gave back most of Tuesday’s gains signals to me that we are likely to make lower lows very soon. 1050 in the SPX by most accounts seems like the next stop, as it was the level in which we bottomed after the indication of QE2 by the Fed late last summer.
The SPX is down about 12% ytd and almost 19% from the May highs, which is clearly not great but you will be hard pressed to find better relative performance in the developed world. The DAX for instance is down almost 20% ytd and 28% from the April highs and seems to be the victim of guilt by association. Chart below shows this most recent under-performance by the DAX.
To state the obvious, the volatility bands have been widened dramatically and while they are not likely to stay this elevated, they will clearly stay above average for some time to come. The VIX spent the better part of the last 16 months on average around 20 but when you look back to spring 2010 you see a similar move in volatility to what we have today and it took some time for things to come down. But when they did volatility creeped out of the market……This does not make for a sound investing environment to say the least, except for those truly long term investors.
The chart below shows the inverse relationship that exists most of the time vs the VIX and the SPX. What I find interesting is how similar the recent move is relative to the period following the flash crash in 2010. The SPX sold off about 17% in the period from early May to Sept 1st, 2010 and the VIX spiked to a little above 45, almost exactly where we are now…..In this most recent instance with the VIX above 40 the SPX is down about 18% from the May 2011 highs.
SO WHAT TO DO NOW? I guess we are kind of standing at the precipice of something big here, and if you are afraid of heights it may make sense to step back a little…..I am fundamentally not a believer in long term investing in the stock market so you won’t hear me say that this could be the buying opportunity of a lifetime…..but I will say to you if you have the flexibility and the risk tolerance to trade on a shorter term basis that there will be amazing short term opportunities to take advantage of this market volatility that will be here for a while…..
If we are in a Bear market there will be plenty of large trade-able rallies and then fantastic opportunities to play from the short side…..
As always move your feet and don’t get stubborn. I remain in camp of caution and personally am doing very little…..I want to place bets on trades like CSCO (read here) where I think sentiment is way over done……
A close below 1100 in the SPX near term would be very bearish…..