Nasty, Wicked, Ugly Reversal

No sooner did the ink dry on yesterday’s blog than the markets saw a very ugly and wicked reversal which saw the Dow give up almost 400 points from high to low. The “feel” I wrote about turned out to be prescient pretty quickly as volatility spiked in a huge way on a relative basis. Check out the chart of the VIX below over the last two days.

When you look at any of the major indices, sector or stocks, you will see what looks like a horrid reversal on the candlestick charts with prices opening at the top of the candle and closing at the bottom, a tall, red candle. The S&P 500 and Russell 2000 are below.

Most of the sectors look very similar to the indices so I will pick on biotech as it gave back the most ground I could find.

While these reversals look absolutely terrifying on the surface, especially when we hear pundits invoking the peaks in 2007 and 2000, historically, their bark is worse than their bite. Some do lead to declines with some declines of major significance. However, most just lead to a short-term bout of weakness or a mild pullback. Several other warnings would need to be present before I would consider one of these reversals to be ominous.

Of note, high yield bonds finished higher on Tuesday along with consumer staples which is now on breakout alert. Utilities are the sector which has been decimated as bond yields have jumped. They are getting close to an area where regardless of where they are ultimately going, a rally should begin.

I wrote about volatility picking up and that’s exactly what’s happening now. However, contrary to popular opinion, bull markets do not end with volatility just increasing from all-time or yearly lows. It’s months or more to work that higher before a bear even becomes possible. Breaking the back of a bull market is not a point in time. You can certainly expect the bulls to make a stand sooner than later.

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Volatility Index Acting Weird as Stocks Just Continue Higher

A new week begins and to no one’s surprise, stocks are set to open sharply higher. Even during the Dotcom bubble, stocks took a breather every now and then. In fact, they became very volatile during their melt up phase. That’s an element that has been lacking during this leg of the bull market.It’s not a great chart, but take a look at the volatility index below, also known as the VIX.

Essentially, since the year began, this index has gone up along with stocks, That is very unusual behavior as historically, stocks and the VIX move inversely, meaning they move in opposite directions. Behavior like this would typically lead to a pullback in stocks, but as we have seen time and time again, this is anything but a normal market environment. It’s something to keep an eye on.

I hate to use the word “feel” because as my golf coach would always lecture, “feel is not real”, but I do get the feeling that one of these sharply higher openings is going to be met with a nasty reversal to the downside. It may only last a day or even a week, but it should look a bit ugly. In this case, the VIX should likely spike higher than normal. Again, we’ll see.

Stocks continue to do nothing wrong to derail the bull market. The major indices are all in gear to the upside. Sector leadership is very strong. High yield bonds are participating. The NYSE A/D Line is making new highs. Nothing suggests an imminent end to theĀ  bull market, no matter how uncomfortable price action makes you.

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So Far So Good!

Just two ago, I wrote about the stock market “groping” for a bottom and laid out a scenario for that to begin on Wednesday. The beaten down Russell 2000 was the key as it very quietly had been outperforming the market for three days. That behavior is not what you typically see if a crash was unfolding. Our indicators and systems backed up my own thoughts and our equity strategies went to maximum exposure at the close on Wednesday.

When I woke up Thursday morning and saw the global stock markets in collapse, I thought it was going to be a truly interesting day. With so many things looking good a few hours earlier, I was either very wrong, which has happened before and will happen again, or this sharply lower open was an absolute gift to the bulls. At this point I am very glad I stayed the course and even took what I would classify as personal gambles at the open by buying oil and shorting the VIX.

After the lower open, stocks staged a very impressive comeback and the internals looked much better along with sector leadership. Our own flagship sector strategy has had a very tough month coming in to this week, but as with the Russell 2000, it bucked the market downtrend and closed higher on Tuesday, Wednesday and Thursday. For the past week or so, I have strongly suggested that clients add money right away as this correction was nearing an end. And I followed my own advice by making my kids’ college fund additions as well as my 2014 retirement plan contribution into the market weakness.

Time will tell if we just saw “THE” bottom or “A” bottom, but even if stocks don’t go right back to all time highs, the preponderance of evidence suggested a good rally was close at hand. There are two scenarios I am watching now and I will spell those out in the Street$marts edition I am currently writing.

Remember, the largest one day stock market rallies usually occur after a decline. In 2008, we saw 4-8% one day moves many times. The larger the decline, typically, the larger the snapback. If you hated certain stocks, ETFs or funds on the way down, use the strength to rebalance your portfolio the way you want.

I am keenly watching how the plain vanilla high yield (junk) bonds funds act now. They are very stretched to the downside and are supposed to rally smartly. It’s put up or shut up time for the short-term, intermediate-term and perhaps even long-term.

Finally, I mentioned watching Apple and Netflix for signs of leadership. Apple hung in really well and should see new highs this quarter. Netflix announced bad earnings and was bludgeoned. IF this is the final rally of the bull market, IF, I would expect the rally to leave many key stocks behind. In other words, it would be narrow. The rising tide would not lift all ships. Again, IF.

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Bulls Step Up… Kinda Sorta

What a great day I had in New York with my friends at Yahoo Finance and Fox Business. In all, there should be five segments posted over the coming week. I began the day at Yahoo with Jeff Macke doing a piece called The Rally Has Begun and Here’s How to Play it. Click on the link and let me know what you think. This was the “calmest” of the three segments!

Changing gears, here are some comments from recent action that dovetails nicely with the Yahoo piece.

A few days ago, I discussed how the stock market was oversold in the short-term and due for a bounce, but that a better intermediate-term low was probably near here yet. With a wicked reversal on Tuesday and follow through on Wednesday, the bulls drew a line in the sand and stepped up. This action was important in preventing prices from snowballing lower. Stock market behavior around tax day hasn’t been that kind to the bulls historically, so it was good to see the tide stemmed.

Several things continue to concern me looking out beyond a few days or weeks. We still have not seen the fear index (VIX) even pop above 20, let alone show real despair. Over the past year and change with almostĀ  no downside, the VIX spiked north of 21 at bottoms. Treasury bonds continue to make new highs for 2014 and even closed slightly higher today when they should have been down 1%. Whether it’s looming trouble in the Ukraine or a slowing economy, it’s not a positive for stocks.

Finally, sector leadership has viciously rotated and the new leaders are indicative of the final stage of a bull market. Energy, REITs, staples and utilities continue to push higher.

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