Is This An Oversold Bounce, Or The Start Of A 10% Correction?

August 8, 2014 3:20 PM

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 Is This An Oversold Bounce, Or The Start Of A 10% Correction?

There are some signs we could be nearing a meaningful bottom, yet there are others this is just an oversold bounce and more pain to come.

First off, the good news and why a major bottom could be near.  The CBOE options equity put/call ratio is nearing a very high level – suggesting there’s a lot of fear in the options market.  I’ve been talking about this one for a while now as a concern, but I’d say it is now more a positive than negative.  Still, the bottom line is the trend, as this ratio tends to trend inversely with the SPX.  This ratio is now high, but I’d need it to reverse lower to become comfortably bullish. 

Looking at the AAII sentiment poll, the number polled that consider themselves bearish is at its highest level this year and highest since August ’13.  That is a good sign, as the masses are getting worried after the recent weakness. 

Also, the bulls haven’t been greater than the bears for three straight weeks.  The last time we saw that much persistent worry was May ’13. 

Lastly, the NAAIM survey just outright panicked.  I like this survey as it looks at what real active managers are doing.  Well, this one just dropped 38% in one week to 51 from 82.  In fact, the 31 total point drop was the 7th largest one week drop all-time. 

Now for the bad news and why any near-term strength could be just an oversold bounce.  The AAII and NAAIM might be panicking, but the Investors Intelligence poll has had bulls greater than 50% for 24 weeks in a row.  This is now tied for the 4th longest streak ever.  That is a lot of persistent bullishness. 

Seasonality isn’t doing anyone any favors here either, as we are in the midst of the only two months to average back-to-back negative returns going back to 1950. 

Plus, when August is negative, it is really negative.  Going back to 1980, there isn’t any month with a lower average negative return than August.  August isn’t off to the best start in ‘14, so if that continues a good deal of more pain is likely. 

Lastly, the VIX futures recently turned inverted.  I explained this in detail here, but the bottom line is this has been historically very bullish.  My take is it is a sign of an extreme amount of panic and since late 2012 it has marked some huge buying opportunities. 

Well, a week from the latest signal, the SPX was down over 1%.  This is actually the worst one-week return since late ’12.  Is this formerly bullish indicator fading?  If so, could this be a major clue something under-the-surface has changed and this pullback is something much different than we’ve seen in a long-time?

There you go.  I’m torn on what could happen next.  There are some good arguments to both sides.  Some sentiment signals are flashing major buys.  Also, you have to side with the bull market, as it has earned our trust.  Still, seasonality and the poor results after the VIX term structure inversion are huge concerns of mine right here and now.  If we turn back lower next week that could be a sign something indeed big has changed. 

Thanks for reading. 

 Picture courtesy of CollegeDegrees360.  

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