I’ll just say this, You Have Been Warned! If the SPX closes the day near current levels it will equal a monthly decline of nearly 4%, the worst start since January 2009’s 8.57% decline, when the index was more than 50% lower than current levels. I am not a huge believer in such things like the “January effect/barometer – as goes January stock market performance so goes the year”, or something to that extent – seems a bit arbitrary. But, 2014’s early weakness seems about right considering investors’ absolute refusal in 2013 to acknowledge any and all potential future headwinds domestically with a FED focused on pulling back from QE at a time when it appeared that housing gains had stalled, consumers remain strained, and jobs growth remained fairly anemic. The curve-ball so far hasn’t really been domestic data (despite a fairly mixed Q4 earnings season), but concerns about credit and currency palpitations in emerging markets. Most market participants would agree that if it turned into a crisis, similar to what we witnessed in Europe in 2011/12, U.S. markets would not be immune.
I have no idea whether we get a crisis, but one thing for certain, volatility of risk assets heading into 2014 was not pricing one. That low vol expectation is a big reason for the helter skelter action ytd. Investors were not prepared, and obviously lulled into complacency. Back on Jan 13th in this space (here) we highlighted this fact and suggested things could change and soon:
Those waiting for a pullback must be asking how long could this actually go on for? Your answer is as good as mine, but make no mistake about it the inverse relationship between the price of stocks and the volatility of the underling CONTINUES to stretch, which only suggests that there is a too much complacency among equity investors. Could this overshoot all logical expectations? Of course. The 10 year chart below of the SPX vs the VIX should suggest a bit of a reversion at some point soon though.
The main takeaway, if we are going to continue to hear terms like “hard landing” & “credit crisis/contagion”, then things could just be starting to get interesting, and volatility is likely still under-priced. From where I am sitting, Treasuries are likely to tell us much of what we need to know. After the Fed acknowledged that they are continuing their Taper the other day, yields continue to come down as investors reach for safety. A sharp reversal here could signal the all clear for U.S. equities (wrote about it in this space here yesterday).
On the flip side, as investors got conditioned to buy dips in 2013 (wrote about it here Monday), there seems to be absolutely no reason to do so until the SPX trades with just a little bit of fear testing the all important and increasingly massive technical support level at 1700 (below circled). The SPX has not breached the 200 day ma since November 2012, the longest such period of avoidance in almost 10 years!
One last point – on yesterday’s bounce, we went through a slew of charts for ourselves, and the large cap stocks seem to fall in one of the two categories. Either they’ve already broken support (like BRK/B, XOM, C, PG, etc.), or they’re ignoring the market weakness for the most part (GOOG, WFC, CMCSA, UTX, etc.). A possible tell for when this correction might end is when those leaders in the second group start to see some capitulation selling.