Turmoil In the Equity Markets

The second week of the Q4 of 2018 saw the biggest decline for S&P 500 since the week of March 23, 2018 (see Fig. 1). What is more concerning is that 14-week RSI made a bearish divergence during the week of September 17, when the index made a  new all time high. In the week of January 22, the index made a then all-time high of 2872.87 and RSI was 90.54. In the week of September 17, the index reached 2940.91 but the RSI only reached 68.42. The RIS has not fallen below 50.

For the week, global indices declined sharply with increased volume. The table below shows how the major global indices fared. Asian bourses did pretty badly compared to Europe and North America though Indian Sensex eked out a positive week after making a reversal doji on Thursday. The table does not show Latin American indices, which also did not do well. Brazil, however, was positive for the week though it made a shooting star candlestick pattern.

U.S.A	Europe	Asia
Dow Jones Industrial Average -4.2% S&P 500 -4.1% NASDAQ Composite -3.7% Russell 2000 -5.2% Dow Jones Transportation Average -6.4% NYSE Composite -4.3% Wilshire 500 Total Market Index -4.2%	Germany -4.9% U.K. -4.4% France -4.9% Spain -3.8% Italy -5.4% Switzerland -4.2% STOXX 6000 -4.6%	Shanghai -7.6% Hong Kong -2.9% Tokyo -4.6% Sydney -4.7% Mumbai +1.0 Seoul -4.7% Singapore -4.4%

With global markets in turmoil it is good idea to take a look at the psychological indicators and market internals. For brevity, we will restrict our analysis to U.S. market only.

The detailed analysis is below but what it shows is that the psychological indicators are flashing signs of increased anxiety, which is natural due to the considerable decline seen by the equity indices over a short period. However, the anxiety hasn’t risen to crescendo and the indicators have also not reached levels commensurate with the market reversals.

AAII Investor Sentiment

The last AAII Investor Survey, on October 4 2018, before the sharp decline on October 10 and 11 showed the investor optimism at its highest level in eight months.

Bullish Sentiment, the expectations that the stock market will rise over the next six-months was at 45.7% from previous week’s reading of 36.2%. This is the highest level since the week of February 12, 2018, when the bullish sentiment was 48.52%. Bearish Sentiment, expectations that stock market will decline over the next six months, was at 25.1%, which was a five-week low. Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, dropped by 3.5% to 29.2%.

To put this in perspective, the historical average for the bullish sentiment is 38.5%, bearish sentiment is 30.5% and neutral sentiment is 29.2%.

On January 4, 2018 the bullish sentiment was 59.75%, which is the highest level seen in the last 5-years. On January 26, 2018, the S&P 500 touched 2872.87, an all time of high at the time. Following the euphoric Bullish Sentiment level, the S&P 500 declined by -11.8% to a low of 2532.69 on February 9, 2018 and then took seven months to regain the January high.

On October 4th, the S&P 500 started a six-day losing streak. On October 10, the most recent AAII Investor Sentiment survey came out with Bullish Sentiment dropping to 30.6%, Bearish Sentiment rising to 35.5% and Neutral Sentiment also rising to 33.9%. The pessimism or the Bearish Sentiment rose to 3-month high and above its historic average for the fourth time in five weeks.

At extreme readings, this gauge works as a contrarian indicator but at other times, it provides signs for future direction of the market. We have found that the current slope of the 4-week simple moving average of the bullish percentage gives a good sign for the slope of the S&P 500 4-weeks later (Fig. 2). Also, the spread between bullish and bearish percentages gives a hint for future direction of the S&P 500. The current trend is moving sideways just above 0, which indicates some level of uncertainty. If it drops below zero then it will increase the chances of current spate of declining days to last longer.

Business and Consumer Sentiment

The Revised University of Michigan Consumer Sentiment recorded a reading of 100.1 in September 2018. This was the third highest level since 2007. The Conference Board Consumer Confidence Index rose to 138.3, the highest level since 2007. The NFIB Small Business Confidence Sentiment index jumped to 108.8, also highest since 2007.

A composite index of these three sentiment surveys has good correlation with S&P 500 (see Fig. 3). However, this, like all sentiment indicator, is not a leading indicator and does act as a contrarian indicator at extreme levels, which calls for some caution at the current juncture.

The Preliminary UoM Consumer Sentiment dropped to 99.0 in October, it is still above the 12-month moving average of 98.3.

The small decline was due to less favorable assessments by consumers of their personal finances. Unfortunately, the downward revisions in the rate of growth in household incomes were accompanied by upward revisions in the year-ahead expected inflation rate, weakening real income expectations.

Market Volatility

The market volatility was subdued for most of 2017. The CBOE Market Volatility or $VIX mostly stayed below 12.5 from September 2017 to late January. It flared up in February 2018, when the S&P 500 declined by more than 10%. After reaching 37.32, the highest level since August 2015, in early February, the $VIX gradually declined, though it did not reach the low levels that were prevalent during most of 2017 (see Fig. 3).

Since August, this Fear-Gauge has stabilized between 15 and 12.5 but that stability has come under pressure in October and $VIX is now at the highest level since the June 2018. On October 11, the fear gauge or $VIX rose to 24.98, which is the highest level since February 12, when it was coming down from the high of 50.30 on February 6, which is the 3-year high mark.

The rising $VIX represent higher uncertainty in the market, which in turn results into risk avoidance and lower market index levels. It is at an elevated level but historically, the market turnaround occur at even higher levels, which means that there is good chance the current decline may last a bit longer.

Put-Call Ratio

The Put-Call Ratio, which compares the total number of puts traded with total number of calls traded on CBOE was 1.050 on October 12.

The 10-day simple moving average is 0.946. Both , the ratio and its 10-day moving average, are rising since late September 2018.

More call options than put option mean that the market is bullish. However, a rising ratio means that the bearish bets are increasing. Usually a reading above 1.15 hints of a near-term reversal in price.

The ratio is still lower than the level that it reached in early July and early April 2018, when it reached 1.180 level. It is reaching the levels reached at the end of February and early March (see Fig. 5). At that time, during the week of February 5, 2018, S&P 500 made the first attempt to reverse the decline after making a low. During the week of April 2, it almost tested those lows and then reversed course and trended higher.

High-Low Ratio

The IBD proprietary High/Low Ratio was 0.18 on October 12, 2018. It has been declining since mid-September. During a correction or falling market this ratio falls toward zero. A bottom in the market usually occurs when the indicator turns up after falling below 0.5. During the bear markets, when the S&P 500 and NASDAQ Composite are below their 200-day moving averages, the initial trigger level drops to 0.1. We are not technically in bear market but S&P 500 and NASDAQ Composite are below their 200-day moving averages.

The NYSE New High / New Low ratio (see Fig. 6) has been on a downtrend since late August, though it  has not made a higher high since early July. The ratio is at 0.0339 on October 12. In February, it reached a low of 0.028 before reversing and the market also turned around along with it.