Was Friday A Capitulation?
A: In my opinion, no. This is the trader in me talking here. I do keep an active trading account open, and if you want some disclosure, I have been trading the ultra short ETF's (SKF, SRS, EEV, FXP, SDS, DXD, DUG, etc..) since Sept-Oct (1, 2, 3, 4 discussions on this) of last year; when the credit markets really started to deteriorate before the equity markets followed. Friday's selloff was a 2x4 hitting equity investors in the face, waking them up to reality (so to speak) that macro forces don't go away so easily! But I did not get the sense of fear that would characterize a capitulation day. While it certainly felt painful to many, give us a day where the equity markets hit an intraday low of down 5-6%, and then we could talk about a flush-out of the system. For me, Friday's selloff was a stepping stone of fear.
Take a look at the VIX (which is an index of short term volatility and widely used as a measure of investors' fear level - the higher the VIX, the higher the fear; for traders, you sell your long positions when fear is low, and buy into new long positions when fear is very high after the selloff), and you will notice that it jumped 26% on Friday's selloff:
In the past 6 months, the VIX hit this level on the upside 5 times (shown on the above chart), excluding Friday's move. When I look back at the week FOLLOWING the vix reaching the current level, the S&P:
#1 (DEC 11th - 18th) - 1,477 to 1,445 or DOWN 2%
#2 (JAN 4th - 11th) - 1,411 to 1,401 or DOWN 0.7% (with a 5.1% drop 3 weeks following)
#3 (JAN 16th - 23rd) - 1,373 to 1,338 or DOWN 2.5% (S&P surged 25 pts on the last day)
#4 (FEB 28th - MAR 6th) - 1,367 to 1,304 or DOWN 4.6% (hitting 1,273 4 days later)
#5 (APR 14th - 21st) - 1,328 to 1,388 or UP 4.5% (only time in the past 6 months that S&P rose the week following a rise in VIX to the level reached on Friday)
#6 (JUN 6th - 13th) - ??????????
I only went back 6 months for this out of my own curiousity and because I wanted to see the reaction in the equity markets to the VIX in this current credit crisis cycle. Interesting nonetheless.
This tells me that investors' fear level jumped Friday, but it's not the capitulation that may mark a tradable bottom (like the intraday low hit in January when SocGen news broke, or the closing low in early March before the BSC news hit). Both those events had several days leading up to the low hit. Friday's selloff seemed more to me like a stepping stone in fear, waking us up to the multiple whammies of a credit crisis, housing recession, oil surge, weak jobs report, and weakening economy. It was like someone said, "...ummm, what the hell just happened", instead of saying, "....holy s#@t....the market's are getting destroyed!!".
As stupid as this sounds to non-traders, we must have the destruction in order to ultimately get through this in terms of pricing risk into equities. Since the stock market as a discount mechanism is the preferred gauge of the economy for so many people, and a measure of paper worth for so many people, this topic is important to discuss. For those interested in how I treat days like this, I sell out of some of my ultra short positions, limiting my short exposure and taking some profits yet still holding 40-50% of the original total position. Since August, I have been focusing my trading strategies on timing the short plays; getting long (which means short) on the rallies, and lightening up (which means exiting the shorts) on the selloffs; I don't always hit the tops & bottoms, but for me, I fine tuned my strategy after years of trading and following the equity markets. I am not long any positions and usually hold any one trade for 1-2 months, from opening the position to closing it; a far cry from the minute-to-minute trader I used to be from 1998-2004 with Tradescape (now Lightspeed Trading, LLC)
With the VIX surging on Friday and the perfect storm of macro forces at play, we are at a new step of fear. As the VIX climbs, the destruction day gets closer. Even if an event can be avoided, an escalation of fear could cause a crisis of confidence that in and of itself causes the event leading to the capitulation. That's how this cycle usually works. Expect volatility to be high as long as the VIX is above 23-24, and be especially cautious if it rises above 30.
Comments (10)
Noah,
I don't know if you regularly check bonddad, but it seems right up your alley.
All indicators are heading SOUTH, and further south. TED, OIS, etc. All ugly.
Posted by brenda | June 8, 2008 7:15 PM
thx Brenda! I'll check it out..
And yes, as usual, your right! Although TED came in a lot last few weeks...that could change very fast.
Posted by Noah | June 8, 2008 7:51 PM
Noah,
I agree, the capitulation phase of this leg down has not been hit, but I think a really good investing buy point will be offered up in the next month or two, after which the less worse bull market I have been talking about will get underway. Most of my Wall Street friends are very bearish, but not one of them has been able to name a new factor which is really scaring them. It's all the same stuff you and I have been talking about for 9 mos. Yes energy has gotten worse, but it's a self correcting market (the higher it goes the less we will use). In the meantime, check out Tom Brown's latest posts on sub prime losses, and the Business Week economist's piece on strength in the economy away from autos and homes in this week's BW. I am a contrarian (maybe to a fault) and also a little tired of being bearish, but i just don't see the end of the world coming from factors everyone already knows about. I am a buyer on the coming puke out and I think equities will be a better place to be versus real estate in the next 12 Mos. After all, they are not the eye of the storm.
Posted by jeff | June 8, 2008 8:08 PM
"Yes energy has gotten worse, but it's a self correcting market (the higher it goes the less we will use)"
I respectfully disagree. Perhaps there is some correlation between cost and usage, but I would argue it's relatively inelastic - both for need reasons (we still need to use energy) and for "want" reasons (America's still love their SUV's, their BBQ's, their HVAC...)
Posted by Anonymous | June 8, 2008 9:12 PM
Noah,
What effect do you think an increase in "The Fear facor" will have on Manhattan real estate?
Mike
Posted by Mike | June 8, 2008 10:47 PM
Mike - well this discussion was a stock market discussion, not a Manhattan real estate discussion. With that said, it is the capitulation and the severity of the event that causes it that will be the factor in determining the ultimate effect on confidence here in Manhattan.
If its an inflation/economic dataset that far exceeds/below what we were looking for, than clearly it wont be as bad as if a LEHMAN goes the way BSC did. A shop on wall st going out will have the sharpest reaction on our local real estate market. Any bad data that causes equity losses will have a ore muted impact on confidence that could lead to a slower loss of confidence over time, as reality hits home for the individual.
Posted by Noah | June 9, 2008 8:29 AM
Speaking of Lehman, $3b loss instead of $300m is a difficult way to start the week, but hey, Wal-Mart and McDonalds are doing well so the economy MUST be OK. I must say that I'm losing faith in Bloomberg.com.
Oddly, the Gasp-Man himself came out and predicted that Lehman won't be around to malign within six months. What a difference a couple of billion dollars can make.
Posted by brenda | June 9, 2008 9:15 AM
Speaking of Lehman, $3b loss instead of $300m is a difficult way to start the week, but hey, Wal-Mart and McDonalds are doing well so the economy MUST be OK. I must say that I'm losing faith in Bloomberg.com.
Oddly, the Gasp-Man himself came out and predicted that Lehman won't be around to malign within six months. What a difference a couple of billion dollars can make.
Posted by brenda | June 9, 2008 9:16 AM
I started hearing LEH rumors the week of May 19th when LEH was around $43/share..was talking to ACCRUED INTEREST on his post on May 29th, about what I hear a week or so earlier:
https://www.blogger.com/comment.g?blogID=30643134&postID=4943513400833286977
*2nd comment, at end!
Too bad I didnt have balls to short the stock though as I am long SKF, and long ton of ultra shorts at that time.
Posted by Noah | June 9, 2008 9:34 AM
Anonymous,
You are correct that in the short-term oil demand is relatively inelastic, but in the longer-term it has proven quite elastic, as it did in the early 1980s. Business Week just showed some stats on SUV sales (down 30%+) and Honda Civic sales (up 30% +) year-to-date....that's elsaticity of demand for gasoline at work. Currently, the market is testing the level at which demand destruction will ensue. When we get there oil prices are likely to settle down, while energy saving efforts will begin to take effect. It's true that spikes in energy prices hurt the economy, but they can't last forever. It's also true that a higher oil price is a tax on growth and since we are likely at peak oil production levels there will be a tax on growth for many years to come, until other sources of energy become relevant (which will take many years). However, the big losers will be emerging markets countries where fuel is subsidized and as the world economy slows they will be forced to stop subsidizing (as India has just begun to do) this will allow thr rationing effect of higher prices to take hold (I would argue that elasticiy of demand for oil is way higher in these geographies, so there will be a big impact).
Posted by jeff | June 10, 2008 8:33 AM