After enduring the worst pasting in years, the bulls managed battle to a draw on Thursday, recovering from early losses, amid an ongoing breakdown in market liquidity and an increase in volatility across asset classes.
In the end, the Dow Jones Industrial Average lost 25 points, or 0.2%, while the S&P 500 gained a fraction. The Russell 2000 small-cap index continued its recent outperformance (after falling harder in recent weeks) to gain 1.5%. The Dow tested below the 16,000 level for the second consecutive day.
All the focus is shifting to what the Federal Reserve will do at its upcoming policy meeting at the end of the month. Will they end the QE3 bond purchase program, given the improvement in the job market? Or will they be frightened by the market pullback, global economic slowdown and the turn lower in recent U.S. data such as retail sales, and hold back? Chatter from Federal Reserve officials today on this subject was responsible for the stomach churning volatility.
Whatever the decision, we’ll know more on Oct. 29.
The other big news, aside from the still very scary situation with Ebola in the U.S., is what’s happening in the eurozone as the 10-year Greek government bond yield exploded above 9%. Doubts continue to grow over the European Central Bank’s ability to keep borrowing costs down amid the realization that its feints towards a Fed-style QE bond buying program could merely be bluffs. This comes amid new political turmoil in Athens as it prepares to exit its bailout program.
Long story short: Europe was never fixed.
With so many big balls in the air, the market is starting to suffer dislocations — big, jumpy moves from tick to tick — as liquidity dries up amid the increase in volume and volatility. You can see this in the intraday chart of the U.S. Oil Fund (USO), shown below.
Still, on a number of technical measures the market is severely oversold here and is vulnerable to a short-term relief rebound at the very least. Small-caps seem ready to lead the way as the Russell 2000 triggers a buy signal — by flipping its stop-and-reverse indicator as shown above — for the first time since August.
It’s for this reason that I recommended Edge Pro subscribers use the market chaos on Wednesday to close their October options positions, bagging a gain of 551% in their iPath S&P 500 VIX Short-Term Futures ETN (VXX) $30 calls and a 287 percent gain in their $35 puts against Intel (INTC).
The strength and participation in this relief rebound will hint at what comes next. But a recent breakdown in big tech and financial stocks leads me to believe this will merely be a dead-cat bounce that resolves to the downside with fresh lows as we head towards the mid-term elections in November.
If so, that lack of liquidity and market depth could result in more price dislocations, bringing back memories of the 2010 “flash crash” event as the Nasdaq Composite, shown above, threatens to close below its 200-day moving average for the first time since 2012.
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Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.
