Complacency Kills: Dave's Daily

How to explain the market decline? Investor complacency coupled with the Goldman Sachs fraud charge among other negative factors.
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Dave's Daily

By Dave Fry, founder and publisher of

ETF Digest

and author of the best-selling book

Create Your Own ETF Hedge Fund.

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April 16, 2010

COMPLACENCY KILLS

If you've been following along here and elsewhere, you've seen the VIX steadily drop.  The low levels of roughly 15 it reached just yesterday was a clear sign of investor complacency. All the other negative factors were in place for a market decline including: high PEs; many overbought measures including both high McClellan Summation Index and RSIs; a property bubble in China and threats to tighten; light trading volumes in U.S. markets on index price increases; the contradiction of high prices for Consumer Discretionary and Retail sectors versus continuing high unemployment; the zero inflation canard and so forth.  Toss-in options expiration, strange disappointment with Google's earnings and an SEC civil suit against GS and the ingredients were all in place for an "event". 

You know what hit the fan Friday as the bullish rubber band was stretched too far.

Everything got sold from stocks to commodities as stops were hit and

Da Boyz

in the options pit had a field day hunting down strike prices in anything. The big market movers to the upside were (you guessed it) bonds.

The only thing we predicted well, or did well in, was volume would increase and today would be more "interesting".  That was true in spades. This repeats a pattern of previous down days where volume explodes and stops are hit. Then, if previous patterns repeat, stocks will rebuild on light volume as markets are still dominated by trading desks and a handful of hedge funds. As long as the punchbowl's in place that's what will happen.

Breadth?  Well, it wasn't a 10/90 day on the downside but close enough to make you nervous.

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The NYMO is a market breadth indicator that is based on the difference between the number of advancing and declining issues on the NYSE.  When readings are +60/-60 markets are extended short-term.

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Per Investopedia:  The McClellan Summation Index is a long-term version of the McClellan Oscillator. It is a market breadth indicator, and interpretation is similar to that of the McClellan Oscillator, except that it is more suited to major trends.  I believe readings of +1000/-1000 reveal markets as much extended.

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Per Investopedia: The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge".  Our own interpretation is highlighted in the chart above.  The VIX measures the level of put option activity over a 30-day period.  Greater buying of put options (protection) causes the index to rise.

Continue to Major U.S. Markets

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Continue to U.S. Market Sectors, Selected Stocks & Bonds

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Continue to Currency & Commodity Markets

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Continue to Overseas & Emerging Markets

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Continue to Concluding Remarks

Complacency is just one of many enemies investors can face.  As the VIX dropped many kicked their feet up and went forward with buying. Judging from volume the previous two months not many have been participating in the latest bull move higher. It's been a trading desk affair along with a few hedge funds.

Friday markets were hit by a confluence of conflicting news from China, Consumer Sentiment, Google confusion, overbought conditions, options expiration and a Goldman Sachs SEC civil lawsuit. Volume was twice that of the previous sessions over the past two months. Breadth sucked and everything but bonds and the dollar were kicked out of portfolios.

As to Goldman Sachs I'm not surprised by the news.  But, I'll also suggest when you create a new mandate for banks to lend money to people who previously would not qualify you're asking for trouble. This simply means that resourceful and creative new product engineers would figure something out to make this happen.  Subprime mortgages were the answer as long as the credit rating agencies and monoline insurance companies played ball. It didn't take long for Wall Street to realize it could make a lot of money doing this with the associated derivatives. So, you give

Da Boyz

enough rope and you get what you ask for. Do I have any aloha for GS? None whatsoever. Do I have any aloha for those that created this mess in the government that led to the demise of Glass-Steagall and created this mortgage mandate?  None whatsoever.

Is this the start of the big correction everyone's been expecting? That's hard to say since we've had these abrupt heavy volume sell-offs before only to see markets rebuild on light volume. Once again, as long as the punchbowl remains in effect, markets may just rally

once again

. What else is there for them to do with free money?

Let's see what happens.  You can follow our pithy comments on

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Disclaimer: Among other issues the ETF Digest maintains positions in: VTI, RSP, MDY, MVV, IWM, TNA, QQQQ, XLF, KBE, XLI, XLY, IYR, TBF, DYY, DGP, UUP, DBB, BDD, XME, EFA, EEM, DZK, EWJ, EWY, EWA, EWC, EPI, RSX and FXI.

The charts and comments are only the author's view of market activity and aren't recommendations to buy or sell any security.  Market sectors and related ETFs are selected based on his opinion as to their importance in providing the viewer a comprehensive summary of market conditions for the featured period.  Chart annotations aren't predictive of any future market action rather they only demonstrate the author's opinion as to a range of possibilities going forward. More detailed information, including actionable alerts, are available to subscribers at

www.etfdigest.com

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Dave Fry is founder and publisher of

ETF Digest

, Dave's Daily blog and the best-selling book author of

Create Your Own ETF Hedge Fund, A DIY Strategy for Private Wealth Management

, published by Wiley Finance in 2008. A detailed bio is here:

Dave Fry.