Stock Options Trading Idea of the Week
Which Way is the Market Headed?
More than anything, I think we can expect the current volatility to come down to earth. In the 10-year back test I performed on SPY, monthly changes of over 10% in either direction occurred less than once a year. The largest monthly drop over those 10 years was 16.7% at the 9/11 terrorist attack (and this was completely made back within 60 days). Last month, SPY dropped 24.8%, eclipsing all other changes by a wide margin. Most of the time, big moves in one month are followed by a smaller move in the opposite direction in the subsequent month.
P/E ratios have fallen to the lowest level in 23 years. According to the NY Times, the estimated P/E ratio for the S&P 500 was just below 12. Over the past century, the average P/E ratio was approximately 15.5.
Stocks, already down about 40%, have already priced much of the doom and gloom in. Only once since the 1930s has the Dow fallen more than 40%. It did plunge 89% during the Great Depression, but then it was sitting on frenzied 500% gains, and the markets lacked many of today's safety nets like FDIC insurance, not to mention a proactive and more-informed Fed and Treasury.
At the risk of being called a hopeless chronic optimist, I think the likely short-term change in the market will most likely be to the upside, but then, my record of short-term predictions has been very close to being right only about 50% of the time.
I feel much more confident about thinking that I really have no idea which way it is headed, and making my investment decisions accordingly. A basic premise that we follow at Terry's Tips is that we really do not know which way the market will go in the short run, and it is best to create positions that will gain if the market moves moderately in either direction (as you may recall, we always make good gains if the market stays flat).
If the market does move more than moderately in either direction, we have to be prepared to make adjustments to prevent losses in case the market continues to move in only one direction.
There is something nice about not having to guess which way the market is headed.
Andy's Market Report
It was another devastating week for the market. Credit markets, as seen by the Libor rate , continued to move significantly lower, but unfortunately the move to a more credit-friendly market had no influence on the stock market. Uncertainty surrounding the recent dip into global recession had the market in a continued state of flux this past week.
"We've moved from credit market concerns to economic concerns and people really don't know what the impact on the economy is going to be, they don't know the full impact. The market abhors uncertainty," said Ben Halliburton, chief investment officer of Tradition Capital Management in Summit, N.J.
The instability was plainly evident in the VIX (investor's fear gauge). The popular measure of the implied volatility of S&P 500 index options moved into the 90's. The flight to quality was palpable as the 30-year bond rate moved to its lowest level (3.87%) since it began issuance back in 1977.
Fear came to a head before the opening bell rang Friday. It was thought that the stock market might have to halt trading after Dow, S&P and Nasdaq futures contracts moved sharply lower (5%). The move lower met a threshold set in May 2001 and triggered a suspension in the futures market. It was the first time a suspension had occurred since the "down limit" was enacted.
"We are in a panic mode, I don't know how else to describe it and when you're in panic mode, all rational thought goes out of the window," said City Index chief market strategist Tom Hougaard. "We've just got to let this thing rage. I think we'll see the Dow below 8,000 today."
The Dow didn't quite make it below the 8,000 mark, but did move to new six-week closing lows.
Foreign markets also continued the six-week plunge as many of the major world indexes made new lows.
Has pure fear taken over or have we already become hardened to the realization of the magnitude of this collapse? On Friday a financial headline read, "Traders relieved despite Dow ending down 3.6%". Really?
"Technically we're way oversold," Jason Weisberg, a New York Stock Exchange trader for Seaport Securities, stated. "We have these downdrafts on very light volume. But all that being said, historically speaking this is all unprecedented."
I agree Jason's sentiments wholeheartedly. All of the major indexes successfully retested the Oct. 10th lows and in the process have pushed into an extreme short-term oversold state. The bounce came shortly after the open Friday, but the question is will it continue? We have seen this bounce action twice before off of these levels and each time the market has moved sharply to the upside, but unfortunately the euphoria has not been sustainable.
I do think that the recent spike in volatility shows that we could be forming an intermediate-term bottom here. The gap in the S&P 500 (SPY) from 10/22 is still out there and I would not be surprised to see a move to that level soon. However, the recent Oct.10 lows need to hold. If they are unable to, well, all bets are off. A move below the Oct. 10 lows and I will look for 7700 to 7800 as an area of strong support.
Overbought/Sold Condition Report
Overbought/Oversold for October 24, 2008
Major Benchmarks - Dow (DIA) - 32.3 (neutral)
- S&P 500 (SPY) - 41.3 (neutral)
- Russell 2000 (IWM) - 40.7 (neutral)
- Nasdaq 100 (QQQQ) - 33.1 (neutral)
- Emerging Markets (EEM) - 37.2 (neutral)
Testimonial of the week
"You guys (girl too) are doing an awesome job in the face of a scary market! I'm truly impressed and learning a lot." - Richard S. 10/20/08