In our last submission, I said that, thanks to a dramatic improvement in many sentiment measures, the odds favored higher prices. I allowed that it was certainly possible that we could have lower prices - and that it was also just as possible that the low was in and the Bear Market was over. As it turns out, the pessimism remained stubborn and the market rallied itself out of its Bear Market, taking us to new highs. I have been long since March 18 waiting for signs of a top.
So, did today's dramatic decline mark the top? Is it time to panic? In four words, I don't think so.
Yesterday, I had noted that the VIX was rallying with the market, instead of the usual decline we would expect in a rallying market. Often, this has been a "tell" for a bit of selling, which it was, despite the market making a Bear question his sanity for a few days. That "Tell" got right in spades. Now, however, we have had a huge move in the VIX.
The VIX has been stubbornly high for this entire rally. The VIX is derived from options premiums on the S&P 500. When the VIX is high, it means that options premiums are high. Now, in a world where all interest rates are low and financial companies can borrow money for 0.15%, and where there are untold numbers of derivative strategies with which to hedge market risk, it is not hard to envision savvy fund managers leveraging up on the S&P 500 (for example), hedging with the futures and, then, selling call options with fat premiums against their long positions for a theoretically risk-free return. Which, I believe, is why every time we spike the VIX, the market finds its feet as more money flows in to the market to exploit those premiums.
Not only did the absolute value of the VIX spiked, but the Relative value of the VIX has spiked.
As a general rule, in a Bull market, when the Relative VIX gets above 1.0, we start viewing it as constructive for the market; the higher it goes above 1, the more Bullish it is. At 1.24, the Relative VIX is at levels that have often preceded rallies (at least in Bull Markets, which is what we are in). Now it could certainly go higher - and the market could certainly go lower - but the current levels suggest a constructive view toward the market, even as we acknowledge that there may be some more work for the market to do on the downside.
NAAIM median exposure has been stubbornly lingering around 100, which is a warning level. The thing is, the NAAIM players are smart and are very aware of the trend. They are likely to be bullish for a long time before a major top. NAAIM by itself isn't good enough to pick a top with. Current levels are a bit worrisome, but this reading is from the day before the decline. Next week may well show us a correction in Advisor Sentiment.
Note that NAAIM is not to be viewed as a surgical tool for top-picking - they do know what they're doing. On the other hand, AAII (individual investors) have yet to show more Bulls than Bears for many weeks, let alone showing enough Bullishness to guess at a top. We need many more Bulls before we start looking for a Bear market.
In addition to the lack of Bullishness among individual investors, there are still a lot of net new shorts in the SH. Yes, they have covered something like 32% of their record levels of shorting in the SH (the Short S&P ETF) but the current levels, given the massive rally we've experienced, is both amazing and Bullish. There are a lot of stubborn Bears, still.
Despite the ugly decline, which has marginally turned some of our trend readings, as well as some of our breadth readings, negative, we find reason to be a bit optimistic. Sure, we could do some more to work off the overbought condition, but I still perceive far too many shorts and far too much stubborn bearishness. Plus, the options premiums are more consistent with a ST low than an intermediate-term top. We should remain flexible in here, as things could change, but for now, we are in a Bull market and, despite technical deterioration, we're already seeing reason to be looking for a buyable low, which is remarkable.
Have a prosperous week!
Mark Steward Young
Wall St. Sentiment