The recent stock market mauling indicates their is obvious potential for a decent multi-week bounce, but the era of easy gains may well be ending.
For the last two years, every minor market dip has been a buying opportunity.
The S&P 500 has seen eight pullbacks, with six being paltry declines of less than 5 per cent. Stocks remained above their 200-day moving average for 475 trading days, the third- longest stretch in history.
As noted in recent columns, however, changes in risk appetite have become apparent in the past couple of months.
Although the S&P 500 hit all-time highs in early September, a dwindling number of stocks were participating in the rally, and many were already in individual bear markets.
Additionally, European indices have been losing momentum since June.
Traders should enjoy a relief rally in coming weeks. Last week just 14 per cent of US stocks traded above their 50-day moving averages, a capitulation level associated with near-term bottoms (European indices were even more oversold).
Additionally, US market breadth has improved: Just as September’s index highs masked weakness in many individual stocks, last week’s declines disguised relative strength in the small-cap and mid-cap sectors.
However, global growth fears mean markets may not enjoy the usual quick ascent to new highs.
The anxiety is particularly obvious in bond markets, with average 10-year yields for the G3 countries (the US, Japan and Germany) last week hitting an all-time low of 1.1 per cent.
Such fears don't disappear overnight; expect more market choppiness. Volatility returns to markets Recent stock declines have been the steepest in more than two years, but markets are not in the grip of panic. Instead, we may be witnessing a rational and long-lasting escalation in volatility.
Last week the Vix, or fear index, spent most of last week in the mid-20s, more than double July's multi-year low of 10, but not significantly above its long-term average of 20.
Similarly, the VStoxx, Europe’s fear gauge, surged above the 30 level, indicating a significant jump in volatility but not outright panic.
Fear indices have been very subdued since 2012. The Vix has averaged just 14 over that time, and quickly fell back whenever it came near the 20 level, with the same pattern evident in Europe.
This time things have been different.
There may not be panic, but the breakout to two-year highs shouldn’t be dismissed either.
It signifies that we may be on the verge of a new volatility cycle.
That doesn't necessarily mean 2008-type market swings, but the calm of recent years – some would say complacency – may be giving way to a more traditional and uncertain environment. Nothing strange about sell-offs "Just when you think the sell-off couldn't get any scarier, it did." Market strategist Nicholas Colas' description of last week's bloodletting was, like much recent media market coverage, a touch hyperbolic.
Of course, the role of the media, as money manager and Reformed Broker blogger Josh Brown quipped last week, is to "squirt kerosene on the campfire and really stoke the flames of fear". Which means endless references to past market crashes rather than dwelling on the routine nature of market sell-offs.
And routine they very well are. Since 1950, the S&P 500 has suffered 28 double-digit declines, or roughly one every two years.
Usually, the sell-offs are not severe; as money manager Ben Carlson noted recently, declines of at least 30 per cent happened on just five of those 28 occasions.
Two-thirds of the time, the decline was less than 20 per cent. Losses were below 15 per cent on roughly half of those occasions.
Does this mean current concerns are misplaced? No. Clearly, however, it doesn't pay to see every sell-off as the precursor to a crash. UK stocks cheaper than 2003 British investors could be forgiven for losing faith with equities.
The FTSE 100 spent most of 2014 hovering around 1999's all-time high of 6,950, only for the recent double-digit correction to send the index back down to 6,100.
However, one would be ill-advised to give up on UK equities, which now sport a dividend yield of almost 4 per cent.
As Hargreaves Lansdown noted last week, the FTSE’s cyclically adjusted price/ earnings ratio suggests stocks are now cheaper than in 2003, at the bottom of a bear market that saw stocks more than halve in value.
Things could get get worse before they get better, Hargreaves Lansdown admits. "But when equities are yielding almost twice as much as gilts, you do have to stop and think where you want your long-term savings invested." The Alibaba indicator The S&P 500 peaked on September 19th, Merrill Lynch noted last week, roughly eight minutes after the launch of Alibaba's much-hyped initial public offering (IPO).
Coincidence? Perhaps. Or perhaps a quintessential market-top indicator?
You decide.
