When market action takes a sudden turn toward the dramatic and the prevailing storyline is called into question, the numbers tend to be elevated to a starring role.
Having entered the year riding an excess of certainty about the steadiness of global economic growth, strength of the corporate sector, attractiveness of stocks over bonds, and scripted predictability of central-bank policies, investors have been greeted with upended expectations on most of these fronts.
None of these notions have been decisively refuted. But capital spilling from emerging markets, staticky messages on the pace of global growth and concerns about the duration of developed-world central bank generosity have been just enough to thwart risk-seeking. Recently yields on safe, under-owned U.S. Treasury notes were sent to a multi-week low of 2.6%.
Now, as the crowd tries to come to terms with a 5.8% drop in the Standard & Poor’s 500 index over the first 22 trading days of 2014, many seek the “key number” to handicap whether this is a mere frightful pullback that resets investor expectations — or something worse.
This is always tricky, because the onset of a “correction” of any depth is hard to distinguish from the opening phases of a more damaging bear market. It’s a bit like the first suspect the detectives on a “Law & Order” episode “like” as the perpetrator of a crime: Most of them end up not being the killer – but he plausibly could be.
So here are a few numbers worth surveilling as the story unfolds:
“Important” index levels: If in a foxhole many nonbelievers find religion, in a market selloff many fundamental stock pickers place their faith in the charts. So these are times when we start hearing much more about support levels and moving averages.
The S&P 500 cracked below one would-be support point at 1,770, then another at 1,746, representing November’s low. Now some are focused on 1,736, just a few points below Monday’s 1,741 close, which is its 150-day average.
More prominent is the 200-day average, now 1,707, about 2% below Monday’s close.
What would it mean if the selling picked up after Tuesday's modest bounce and threatened the 1,707 threshold? Well, mostly it would mean the 1,736 “support” wasn’t.
But, less dismissively, the 200-day average is a widely used indicator of the direction of the underlying trend, a general divide between a tape in which buyers are setting the agenda and one where sellers are more aggressive. Trend followers intent on missing “the big one” often use it as a trigger to exit a market, though it often also means missing the first big part of a rebound.
If the S&P reached 1,707, it would also mean stocks would have settled back well below 15-times forecast profits for 2014, which would almost certainly give the “all is well” fundamental investing crowd a tidy excuse to say the market again looks attractively valued.
The VIX: The CBOE S&P 500 Volatility Index principally measures the prices paid for options that pay off with further stock-market declines. It's mostly a real-time reflection of actual stock-market jumpiness combined with traders’ belief or worry that volatility will keep rising or falling.
The VIX closed above 21 Monday, the highest since late 2012. Since the 2011 Euro-meltdown and U.S. debt-downgrade scare, the 20-25 range has represented a crescendo of fear coinciding with at least short-term bottoms in stocks. Before that, in 2011 and, especially, in 2008-2009, anxiety swelled way beyond that.
Currently the demand for protective puts (and the surge in the VIX) has exceeded what would be expected based on the current magnitude of stock-index losses. This represents fear of a self-fulfilling liquidation-related rout in stocks, says Adam Warner, options trader and author on a Schaeffer’s Investment Research blog. This “should” develop into a decent contrary indicator that the selloff is climaxing before very long, but there’s nothing magic about any particular level, and extreme can always get “more extreme.”
Fear & Greed Index: Maintained by CNN/Money, this is a measure of observable signs of investor emotion, and Monday it fell deep into “extreme fear” territory, registering a 13 on a 1-100 scale, only weeks after rising into the 70s. This rapid shuttling from optimism to fright is similar to the one that occurred last spring amid the market tantrum over Cyprus instability and the Federal Reserve’s hints of “tapering” its monetary stimulus.
The weekly Yahoo Finance investor sentiment poll, performed from late Friday through the weekend, finally showed some doubt creeping in, as bullish respondents slid below 40% for the first time in its three-month history.
In looking at over-excited investor attitudes in January, I said market bulls should watch how the market mood reacts to the next pullback to determine if it develops into a high-probability buying opportunity. Barring any major erosion in the economic fundamentals or worrisome weakening of credit conditions, neither quite evident yet, this appears to be the way it’s playing out.
Relative stock-bond yields: This year was supposed to be about accelerating growth and rising interest rates, according to the consensus take. Instead, we’re dealing with mixed economic signals and ebbing rates, which should restart the game of earlier last year of seeking stocks with dividend yields that compare favorably to those of risk-free bonds.
The Powershares S&P 500 Low-Volatility exchange-traded fund (SPLV) holds the 100 stocks in the S&P 500 with the lowest historical volatility – essentially a portfolio of relatively stable, higher-quality large stocks. The fund now yields 2.64%, right in line with the U.S. 10-year Treasury yield. This is the fund’s highest yield since May 2012 and it exceeded Treasury yields for the first time since June of last year.
There is no ironclad relationship here. And, for sure, the low-volatility investing trend is a bit of post-crisis marketing jazz; the stocks could lose a couple years’ worth of the fund’s yield in short order in a market rout. Finally, the SPLV will not likely lead the way higher in any post-selloff recovery in stocks.
Yet, as a rough gauge of investor preferences and relative value, this is worth considering. For the same yield, one can have safety and principal guaranteed in bonds, or a portfolio of good-to-great companies that will continue increasing their dividends over time and participate to a fair degree in future economic and market gains.
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