Stocks are in the midst of their worst downturn since 2002, with the Dow Jones Industrial Average on track for its sixth weekly decline. The catalyst, of course, has been concerns over the future path of economic growth as high inflation, rising gas prices, the withdrawal of monetary and fiscal stimulus, and supply chain disruptions out of Japan all take their toll on output.
As a result, the smallest, riskiest stocks in the market are flirting with the lows from January and March. But some sectors, especially financial issues, have been hit even harder. The likes of Bank of America (NYSE: BAC) and Citigroup (NYSE: C) have returned to levels not seen since the spring of 2009. Two years worth of gains have evaporated on worries over regulatory zealotry and a housing double dip.
But here’s the thing: Savvy Wall Street traders aren’t panicking.
Indeed, the CBOE Volatility Index (VIX), which is based on S&P 500 option premiums and rises when people are afraid and looking for protection, has been stalled in a two-month trading range. It remains well below the heights reached during the Japanese earthquake and nuclear disaster in March.
Translation: Options traders, who tend to be some of the more sophisticated operators believe the selloff will be limited and is nearing its end. And that means it’s time to start looking for opportunities on the long side again.
For sure, history is on their side. Jason Goepfert at SentimenTrader looked back at what happened when the S&P 500 dropped at least 4% and hit at least a one-month low with no corresponding rise in the VIX since 1986. The results are encouraging. A month later, the S&P 500 sported a positive gain seven out of eight times averaging a return of +6.1%. Only twice did the maximum loss exceed -5% while six times the maximum gain exceeded +5%.
The best opportunities to play the reversal seem to be among emerging market stocks, as well as financial issues. Russia in particular looks very strong as the country takes an increasingly assertive role in the global energy markets after OPEC’s latest meeting fell apart in acrimony. The Market Vectors Russia ETF (NYSE: RSX) looks very strong. For individual picks, I like Russian steelmaker Mechel Steel (NYSE: MTL).
As for the financials, they’re benefiting from a surge of buying demand late on Friday after CNBC reported a possible relaxation of capital requirements from the Federal Reserve. This provided a much needed dose of positive news for the beleaguered group. Industry titan Goldman Sachs (NYSE: GS) looks very strong. A simple return to its 50-day moving average would be worth an 8%+ move from current levels.
Disclosure: Anthony has recommended MTL and RSX to his newsletter subscribers.
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