Jeff Cox | @JeffCoxCNBCcom, Topcools republish on 1pm, Jan 20, 2016
There’s got to be an end here somewhere. Right?
One thing for certain about market corrections is eventually they’ll stop. The problem, of course, is figuring out where.
Essentially, the selling stops when all the bears have been exhausted, sentiment completely craps out and there’s simply nothing left to do but buy. It’s called “capitulation.” Market veteran Jeff Saut, the chief market strategist at Raymond James, said Wednesday’s early-day 566-point Dow plunge felt like a possible capitulation point, and the major averages heading into the close were threatening their biggest intraday reversal since 2008.
But how do you know for sure when capitulation is about to happen and it’s time to jump back in the market? Here are 10 time-tested signals for when capitulation is in the air:
1. Oil finds a level. This is sort of the “duh” component, but it’s a key to capitulation, though not the only one. Oil traditionally is a pretty solid noncorrelated asset, meaning it generally has little relation to the broader stock market movements. However, since the plunge in crude the two asset classes have been nearly perfectly in lockstep. For the selling to stop, oil doesn’t necessarily need to rebound to $60 or $80 or $100, but it does need to find a bottom somewhere. “One thing about a bear market is we typically say it’s death by a thousand cuts. It just goes on, it just wears you down,” said Quincy Krosby, market strategist at Prudential Financial. “If this is oil-related and you do see stabilization, perhaps that’s the key. That’s the one catalyst that gets the market back up.” But that’s not all…
2. The Fed. On their own level, Fed officials will need to capitulate and admit that the road back to policy normalization will be rockier than they thought. The S&P 500 has fallen about 12 percent since the Federal Open Market Committee enacted its first rate increase in nine years last month, and the timing simply cannot be coincidental. “No one knows how much the Fed’s liquidity pushed the market higher,” Krosby said. “What’s happening now is the market is doing the unwinding adjustment to find that equilibrium.”
“The market is now expecting at the Jan. 27 meeting that in essence (Fed Chair) Janet Yellen capitulates,” Krosby said. “In diplomatic terms, not saying she made a policy mistake, but that we’re watching events, something along those lines.”
3. The VIX. Traders use the CBOE Volatility Index as a fear gauge to see where options traders think the market is heading over the next 30 days. The VIX was trading above 30 during Wednesday’s blowout, which of course is nowhere near the 80 it hit during the darkest days of the financial crisis, but in the neighborhood that would suggest a fear top. The index did reach an intraday high of 53 during the August 2015 lows, but quickly settled at 40 and took a rather sharp trip down in the weeks and months after.
4. The BRICs. Fund managers surveyed by Bank of America Merrill Lynch report a record level of bearish positions on emerging markets, particularly the Brazil, Russia, India and China quartet. BofAML’s chief investment strategist, Michael Hartnett, said “true capitulation” would need to include a rebound by the BRICs, as well as a decline in the surging U.S. dollar and forced selling of long positions in the FANGs (Facebook, Amazon, Netflix and Alphabet (nee Google).
5. Sentiment. Individual investor surveys as well as positioning among active managers feels like it can’t get any lower, but full panic selling has yet to hit. The American Association of Individual Investors survey reports an 11-year low in bullishness, asset managers have their lowest level of S&P 500 longs since at least 2010 and average cash balances for fund managers, according to BofAML, are at their third-highest level since 2009. However, fund flows show a relatively orderly retreat from the market. Keep an eye on where investor money is headed and how quickly. One interesting number to watch is that total assets for U.S.-based exchange-traded funds have fallen below $2 trillion.
6. Small caps. The Russell 2000 small-cap stock barometer already is in a bear market, tumbling nearly 26 percent from its 52-week high. A stabilization in the equity market’s most vulnerable area will be essential. “What would be suggestive to an institutional investor that the economy is picking up … would be money coming into small caps and mid caps,” Krosby said. “That would give us confidence. The more of that we see, the more investors would feel in the short and medium term to take advantage of the lower prices.” Traders thus far in 2016 have pulled $2.6 billion from the iShares Russell 2000 ETF, according to ETF.com.
7. Earnings. Fourth-quarter earnings have managed to hop over a dramatically lowered bar (a 6 percent aggregate drop forecast for the S&P 500), with 67 percent beating expectations, but investors have not been satisfied. The most glaring example has been in the banking sector, where the big Wall Street institutions all have cleared estimates but have seen their shares decline. As a sector, banks are down 5.9 percent since reporting season began. “In a normal market, the market would reward those companies that are doing well,” Krosby said. “If you see the market punishing those companies that have been doing well, it’s suggestive of a market that has broader and deeper issues.” Netflix, which also reported a solid earnings beat Tuesday, got clobbered Wednesday. That type of price action will have to change.
8. Puts vs. calls. The CBOE five-day average put/call ratio is, as its name implies, a short-term gauge of puts versus calls, or options to sell against options to buy. A high ratio suggests elevated fear. For traders, the magic number is around 1.5, a threshold the measure has crossed just once in recent days, during Friday’s beat down. A reading of 1 or above gets you close, but a move to something like a 1.69, which was the high during the August market slide, would be a convincing sign that capitulation has arrived.
9. Volume. It’s been a phenomenon during the post-crisis recovery that down days generally see heavy volume while up days get far less trading activity. Seeing some conviction come into the market during positive days (which have been scant in 2016) would be a welcome sign. “What you want to see is, are you getting actual buyers coming in, taking advantage of the valuations, which obviously are becoming increasingly attractive,” Krosby said. “You want to see if volume on upside day increases.”
10. When the news doesn’t matter. During the sell-off, traders have been reacting sharply to negative headlines. History has shown that bear markets actually end on bad news — when the market no longer reacts, the bottom is in and the opportunity to buy emerges. Judging by the news flow, there’s a ways to go before that point is reached.
“The core of this is the tug of war between bulls and bears. If the bears are right and recession is around the corner, this market has further to go,” Krosby said. “Traders don’t wait for the Bureau of Economic Research to tell you we’re going into recession. They look for signals in the market, that’s what they do. They sell first and ask questions later.”