Stocks: Beyond the Panic
From a report issued by S&P Equity Research on Oct. 3
We witnessed another panic last week on Wall Street, Main Street, and every other street, as stocks got slammed Monday, Sept. 29, in what could be labeled another "Black Monday." That's two climaxes in September for those of you counting, and we now move into October, which has marked many major bear market bottoms.
We still believe the stock market is close in time to a major bottom, and hopefully, the calendar works in favor of investors once again, as historically, November, December, and January have been the best three months of the year.
Some very interesting milestones were reached on Monday, Sept. 29, and some translated into a technician's dream. When we have to look back many years for times the market has acted like this, we find historic precedents to go by, which raise our confidence just a bit for these volatile times. History says the market goes through an emotional metamorphosis during bull and bear markets. In our view, this can't be further from the truth. As a bear market really gets rolling, fear turns to desperation, desperation turns to panic, panic turns to capitulation, and capitulation turns to despondency.
Finally, despondency morphs into depression, just as the market begins to turn higher. We think it is clear that we have seen panic and capitulation over the last couple of weeks. By the looks of some of my co-workers and fellow commuters, there was a look of despondency and depression on their faces this past week.
On Monday, Sept. 29, the S&P 500 crumbled 8.8%, the largest one-day wipe-out since the crash on October 19. 1987, when the index plummeted 20.5%. Obviously, the 2008 version of Black Monday does not compare with the 1987 version, but was nasty nonetheless. These two Mondays represent the two largest losses for the S&P 500 since 1950. The other infamous Black Monday occurred on October 28, 1929, when the Dow Jones industrial average tumbled 12.8%. This was then followed by Black Tuesday, October 29, with the DJIA toppling another 11.7%. So, keep your chin up, it's not that bad on relative terms.
On Monday, the Nasdaq fell 9.1%, the DJIA dropped 7%, and the Nasdaq 100 declined 10.5%. This was the third largest decline in the history of the Nasdaq, surpassed by the 9.7% dive on April 14, 2000 and the 11.3% plunge on October 19, 1987. Overall, massive one-day sell offs during bear markets have many times been near the bottom of the major downtrend.
Another area where we can point to concerning panic and capitulation comes from market internal data. When investors are throwing stocks out of their portfolios en masse, it represents in our eye a real distaste for the equity markets. On Monday, the NYSE declines/advances breadth ratio surged to a staggering 19.5:1. This topped the 17.8:1 reading on September 15, and was the highest since the 28.1:1 level posted during the 1987 crash. It was also the third highest negative breadth reading on the NYSE going all the way back to 1970.
The other abysmal day occurred on October 9, 1979, when the ratio soared to 26.5:1. Horrendous breadth readings seem to give better buy signals after long price deterioration in the market, something we have currently. They have happened during the majority of market cycles, both up and down, so using this indicator blindly has its faults. Looking at volume breadth ratios, NYSE down volume/up volume rocketed to 39.8:1, the third highest reading since 1990. The same ratio on the Nasdaq was 34.1:1, the highest since October 1997. Clearly, Monday was a one-sided day.
Price volatility has been enormous of late, mostly on the downside, and that is another indication of panic in the marketplace. Since Sept. 4, the S&P 500 has closed up or down by at least 2% on eleven out of 21 days (52% of the time). The range of closing returns during that period was +5.3% to -8.8%. The average daily movement (either plus or minus) during those 21 days was 2.7%.
The last time we have seen that type of price volatility was during the period surrounding the 1987 crash. From October 14, 1987, to November 12, 1987, the S&P 500 closed up or down by at least 2% on 13 out of 22 days (59%). The range of closing returns during that period was +9.1% to -20.5%, quite a bit higher than what we have seen recently. The average daily movement (either plus or minus) during those 22 days was 3.83%, also more severe than current conditions. So, things could be worse.
The volatility indexes continued to spike this week, indicating an extreme level of fear in the options market. The VIX, or volatility index, based on S&P 500 options soared to 48.4% on an intraday basis Monday, the highest reading since July 24, 2002 when it reached 48.5%. That period marked the first bottom during the last bear market. Other extreme readings on the VIX were September 21, 2001, at 49.34, October 8, 1998 at 49.5, Septermber 11, 1998 at 48.1, and October 28, 1997 at 48.6. For the most part, extreme volatility readings have been at or very close to long-term bottoms. That is not to say that the VIX can not go higher due to further weakness in the stock market, but the index is at quite an extreme reading.
Following Monday's fireworks, we had a quick retest of those lows on Thursday, and that test seems to have passed with flying colors. Volume on both exchanges fell sharply during the retest, a bullish sign, in our view. The advance/decline (a/d) ratio and the a/d volume ratio both improved during the test, another positive, in our opinion. The equity-only put/call ratio was higher on the test, while the VIX was slightly lower on the test, and we think both are positives. Interest rates, both short and long, did not fall as much during the test, another feather in the bulls' cap, in our view. And, as we said, the calendar favors the bulls, so stay tuned.