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Is there any more pop after the drop?

Summary:
Mid-week market update: Is there any more “pop” after last week’s drop? The market certainly had a big rally yesterday, and it is not unusual to see a pause the day after a big move.  Here are the bull and bear cases.  Bull case Option based sentiment is supportive of further advances. The history of the normalized equity-only put call ratio is high enough to see stock prices advance when sentiment has been this bearish in the past. That said, oversold markets can become more oversold and we haven’t seen this indicator reverse downwards, which would indicate a shift in momentum. Such an event would be a better trigger for a buy signal.  The put/call ratio remains elevated today and stands at 1.16, which is also short-term contrarian bullish.  Even Chinese stocks seem to

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Mid-week market update: Is there any more “pop” after last week’s drop? The market certainly had a big rally yesterday, and it is not unusual to see a pause the day after a big move.
 

Is there any more pop after the drop?

Here are the bull and bear cases.
 

Bull case

Option based sentiment is supportive of further advances. The history of the normalized equity-only put call ratio is high enough to see stock prices advance when sentiment has been this bearish in the past. That said, oversold markets can become more oversold and we haven’t seen this indicator reverse downwards, which would indicate a shift in momentum. Such an event would be a better trigger for a buy signal.
 

Is there any more pop after the drop?

The put/call ratio remains elevated today and stands at 1.16, which is also short-term contrarian bullish.
 

Is there any more pop after the drop?

Even Chinese stocks seem to be trying to bottom here. The Shanghai Composite hit a 4-year intra-day low Wednesday, but reversed to close higher on the day. This may be an indication of the start of a global relief rally.
 

Is there any more pop after the drop?

I was recently asked about emerging markets. There is a nascent positive divergence occurring between EM equities and EM bonds. The chart below shows the relative performance of EM stocks against the MSCI All-Country World Index (ACWI, blue line), and EM bond price performance against their duration-equivalent Treasuries (green line). The bottom panel shows that the historical correlation of these two indicates has tended to be positive. EM bonds are turning up, but EM stocks continue to lag.
 

Is there any more pop after the drop?

Is this a hopeful sign of a turnaround in risk appetite for the bulls?
 

The bear case

The bear case rests mostly on sentiment. The latest II survey shows that the number of bulls have plunged, but bearish sentiment has not risen. Where is the fear?
 

Is there any more pop after the drop?

These results are consistent with Callum Thomas’ (unscientific) equity sentiment poll taken last weekend. Net sentiment turned more bullish after a -4.1% plunge in stock prices. There may be too much greed for the market to make a durable bottom here.
 

Is there any more pop after the drop?

Speaking of too much greed, the WSJ reported that Wall Street banks told Uber it could price an IPO at a $120 billion valuation next year, which would represent a 66% increase from the valuation from its last financing, which was $72 billion. Too much greed, not enough fear.
 

Don’t overstay the bounce

I resolve the bullish and bearish cases as the market is undergoing a short-term bounce, but it needs a second downdraft to flush out the stubborn bullishness among investors. So far, the market action this week is following the historical October OpEx pattern observed by Rob Hanna at Quantifiable Edges. Historically, Monday has been weak (yes), Tuesday strong (yes), and Wednesday has been weak (sort of), but expect a rebound tomorrow.
 

Is there any more pop after the drop?

My own study of post-October OpEx week shows that Mondays has a bullish bias, but the rest of the week looks relatively normal.
 

Is there any more pop after the drop?

I am also watching the short-term breadth indicators from Index Indicators using different time frames. The % above 5 dma became wildly overbought Tuesday, and therefore is no surprise that the market pulled back today.
 

Is there any more pop after the drop?

Using a slightly longer time frame, the % above 10 dma recovered Tuesday but it was still in negative territory. I would expect this indicator to recover to at least a mild overbought reading before this relief rally is over.
 

Is there any more pop after the drop?

My inner investor is increasingly cautious. My inner trader got long the market last Friday and he is playing for a continuation of the short-term bounce before shorting against either late this week or early next week.

Disclosure: Long SPXL
 

About Cam Hui
Cam Hui
Cam Hui has been professionally involved in the financial markets since 1985 in a variety of roles, both as an equity portfolio manager and as a sell-side analyst. He graduated with a degree in Computer Science from the University of British Columbia in 1980 and obtained his CFA Charter in 1989. He is left & right brained modeler of quantitative investment systems. Blogs at Humble Student of the Markets.

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