foxex: Was that Capitulation?

Chart Advisor | Focus on the Price

Friday, March 06, 2020

1. Bond prices launch higher as stocks catch a bid

2. Riding out a contrarian strategy

3. The only Dow component in the green

Market Moves

Bond yields collapsed today after dropping to historic lows yesterday. Stock indexes also dropped as much as four percent lower before the final hour of the trading day when something amazing happened: shares rebounded. Not just a little rebound, a robust climb that brought all major stock indexes up around 2.5% from their lows.

The range of volatility has increased so much in the past two weeks that this move was more than double the average trading range stocks traded in during the previous month. It is possible that traders simply didn't want to hold a short position over the weekend, or it could be that this dramatic move represented the end of most market participant's capitulation. Considering how widespread the selling, and later buying, was today, this kind of market action may be significant.

The chart below attempts to measure the significance of the current market breadth. The green line is a combined count of the number of Dow component stocks trading above their daily moving averages. The indicator equally weights the 20, 50, 100 and 150 moving averages, and shows a percentage in the scale on the right of the chart of stocks collectively trading below those moving averages. The results show that on rare circumstances (only nine since 2007), the breadth of selling drives this indicator below the -80% line. Buying stocks on or shortly after this signal turns out to be a rather productive strategy on average.

Riding Out a Contrarian Strategy

To see exactly how useful the indicator above was, the chart below displays a weekly-period, 12-year review of State Street's SPDR Dow Jones Industrial Average ETF (DIA) and marks the points at which the previously mentioned indicator hit is lowest extremes. Admittedly the sample size is small, but the results are intriguing. The average return of holding on to stocks for a 12-month period after this signal appears is 14.5%. That compares to a historic range of 7 to 10% for the S&P 500 index (SPX) over the last century, and an 11% annual return for the same index over the last decade. So what's the catch? It's not easy.

Five of these signals occurred in close proximity during days of the financial crisis. The worst case was the first one which ended up creating a 25% loss over a 12-month period. In fact that signal took three years before the markets reached its opening price. The second case was nearly break even. All other signals ended doing far better than the market's average move for a year, but four of them had to ride through more than 10% moves against the opening position.

Buying the dip right now based on this same signal might end up being a valuable strategy, but this data shows it could require some extreme patience along the way.

Read more:

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The Only Dow Component in the Green

During the trading session today when stocks were at there lowest, there was still one of the 30 component stocks in the Dow Jones Industrial group that was in positive territory for the day. It was Walgreens Boots Alliance (WBA) which has inspired investors in the face of Coronavirus fears. Investors likely expect them to do well selling Kleenex, hand sanitizer and Clorox wipes.

The Bottom Line

Bond prices made a staggering jump higher as yields fell precipitously. Stocks ended lower, but had a massive buying move in the last hour. With the Volatility Index (VIX) spiking to 54 and retreating to close at 42, it may signal that the markets have found their lows for now.