By Michael Sincere at MarketWatch
Volatility has returned to the market. To be specific, the market has rallied, sold off, rallied, and sold off, all in one week. This is ideal for day traders but unnerving for individual investors. It is also a big red warning sign.
To refresh your memory, last week every rally failed, so the market ended the week on its lows. Even the October 8th rally of 274 points reversed direction the next day. It was a monster rally based on the FOMC minutes, which revealed member’s concern for global growth. Got that? The market rallied on bad news. In the mixed-up world of Wall Street, that meant interest rates would remain low. Unfortunately for the bulls, the next day the market fell by 334 points. That’s volatility!
In nontechnical terms, the October 8th manic rally was a head fake. It might have cheered amateur investors, but in reality, this has become one of the most dangerous markets since 2008.
Facts are hard to dispute but easy to spin. Already, the Russell 2000 RUT, -1.37% is in a 10% correction. Judging by history, the Dow Jones Industrial Average DJIA, -0.69% and S&P 500 SPX, -1.15% shouldn’t be far behind. A major correction or crash would be definitive proof this market is wearing no clothes.
Failed rallies are extremely significant. Previously, whenever there were major or minor selloffs, buy-on-the-dippers would come in and change the market’s direction. On a chart, you’d see a distinctive “V” pattern as buyers overwhelmed sellers. This pattern has continued for months — until recently.
On the market’s worst days, the Fed would conveniently appear with a new QE program or a promise to keep interest rates low for a considerable time (that’s getting old). Soon, though, these bandages will not work. Failed rallies mean the party is almost over and a bear market is getting closer (and may even have arrived).
In addition to failed rallies, look for more intraday reversals (from a rally to a selloff), and a strong selloff into the close. For years, no matter how bad the news, it was either forgotten by the next day or spun as positive. As the bull market comes to an end, the market will finally react negatively to bad news.
Sell into rallies
Lately, there has been a tug-of-war between the bulls and bears. For the most part, the bears have been winning. If that pattern continues, many traders will sell on the rallies instead of buying on the dip. If selling on the rallies continues to work, that’s further evidence this bull market is on its last legs.
The bulls are going to have to work hard for their money this year, something they are not accustomed to. And the bears will still have to manage explosive one-day rallies. This is what makes this market so dangerous.
It takes a long time for sentiment to change from overconfidence to fear, and right now we’re in the early stages. The recent volatility has upset investors, but there is still little fear. When fear does hit the market, there will be a mad rush out the door that will remind investors of 2008.
At the moment, it’s too early to proclaim that a bear market has definitely begun. Keep in mind that bull markets do not end in a week, as topping out can take time. In addition, bear markets often begin slowly and secretly, and arrive before most investors realize it. I’m convinced we’re close to the end of the topping-out process, but we still need more evidence. The increase in volatility VIX, +13.22% is a significant clue.
There are other clues. For example, New Highs-New Lows have been flashing warning signs for weeks, and the NYSE Advance-Decline line topped out in late August. Although no one can time a market top, these indicators should not be ignored. In fact, judging by the technical, fundamental, and sentiment indicators, crunch time is getting closer.
Be prepared to take defensive action
Remember, Mr. Market always has the last word. My advice to investors: Buying on the dips could be highly dangerous. Review your portfolio and take defensive actions to protect it. This includes buying put options or hedging with ETFs if you are experienced. If you’re not, consider selling a portion of your stock portfolio.
Bottom line: Some believe the long-anticipated correction has finally arrived. My view is that it could be worse — the end of the bull market. Take action before too much damage is done to your portfolio. The last thing you want is to try to get out when everybody else is selling.