The global stock markets ended last year enthusiastically.An almost universal bullishness gave way to a disappointing January. The swoon continued into early February, and markets bottomed early last week, with accumulated year-to-date losses of nearly 7% in the U.S.
Fear Surfaced Last WeekA week ago, coincident with last Monday's 90% down day (down 326 DJIA points), sentiment measures moved back to neutral, with AAII bulls falling in half (to 28%), Investors Intelligence bulls dropping from 60% to 48% and the 10-day put/call ratio moving from 0.71 (multiyear low) to 0.89. (Note: During the free-fall, I suggested that stocks were, for the first time in months, in equilibrium, with upside and downside about equal.) On the following day, Tuesday, put buying surged (put/call pierced 1.60), and the S&P 500 hit a low of 1740 that was successfully tested on Wednesday. At the same time that stocks got oversold last week, Treasuries got over overbought, completing a near-40-basis-point drop in the yield on the 10-year U.S. note from over 3% at year-end 2013 to under 2.60% in early February. (Note: During this rise in bond prices and decline in bond yields, I began to accumulate ProShares UltraShort 20+ Year Treasury ( TBT).) The deterioration in sentiment on stocks and optimism on bonds set up an oversold extreme in equities and an overbought extreme in fixed incomes, leading to Thursday and Friday's big stock market and bond yield rallies.
How Now, Dow Jones?The key question is whether the correction is over or whether late last week was simply a stopping point in a larger-scale correction. Typically stock market oversold rallies last about five to eight days. A healthy recovery off of lows is usually characterized by put buying (persistent skepticism), expanding volume (indicating that the real buyers are back) and good breadth. That said, I continue to see a trend change in the markets -- and not for the better. The positive change from an oversold last week was not that convincing. According to Investor's Business Daily, the two weeks of trading had neutral/negative characteristics: Six out of the seven up days were on lower volume, and four of the five days (with the exception of last Friday) were accomplished on higher volume.
The Return of the Two-Way MarketI suspect that a correction far greater than those experienced in recent years is in the offing sometime this year. The fundamental support for a sharper and sustained market decline ( as I have repeatedly written) is the vulnerability of P/E multiples in the face of less-than-consensus economic and profit (and profit margin) growth (among other issues). But before the trend change is obvious and the meat of the correction occurs and before (and if) it becomes clear we are in "the big one," it seems possible that the jerky up-and-down market action (such as we experienced last week) will be more the norm than the abnormal. A trendless market without memory from day to day remains my best guess for the first half of 2014. This is an ideal environment for opportunistic (and facile) traders but not a desirable backdrop for the buy-and-hold crowd. Thus far, I have more actively traded in 2014 than at any time in recent years. My diary's strategy has been increasingly pointed toward more active trading in recent weeks. That will continue in the weeks and months ahead. However, I recognize that active trading is not for everyone. Most investors should hold on to above-average cash reserves in a market without memory from day to day.
This column originally appeared on Real Money Pro at 8:03 a.m. EST on Feb. 10.