First of all, a mea culpa for my prediction that the fat finger bottom wouldn't be retested. I was clearly wrong about that. I didn't get punished for my call however because I don't bottom pick when "market action" stinks. By market action I'm not just talking about if the market is going up or down but rather the way it goes up or down. For instance, when the market rolls over from a high and starts heading down and then gets slammed for greater than 1.5% closing near the low of the day, that's what I call “poor market action” because the only thing that prevented more downside was the closing bell. Sometimes you get a dead cat bounce the next day but new lows or a retest ultimately tend to happen.
When it comes to trying to pick a bottom during panic conditions, what I look for are days when the market gets slammed after already in the midst of a downward spiral and then reverses course by the end of day finishing in the green or flat. If you look at ST and even LT bottoms, they tend to happen this way (take a look at the Feb 5th bottom as an example) We did see such a reversal day on Friday but the problem with that reversal was that the gap down was immediately bought which to me doesn't indicate the white knuckle fear you see with this reversal bottom pattern I'm talking about. Typically a "true" reversal happens later in the trading day.
Now, I'm not going to bother talking about the specific fundamental issues about Europe. The way I look at it, you have to decide whether you believe this is a similar to the subprime crisis whereby it will lead to a chain of events that create another 2008 style collapse or you believe that this crisis can be contained similar to what happened in 1997 with the Asian Contagion and in 1998 when Russia defaulted causing the collapse of LTCM.
Let's look at historical data for some clues and see how it matches up to the current crisis.
At the height of the crises in 1997 and 1998 we saw the market drop about 13% and 21% respectively from the peak to the intraday low. So far we've seen about a 13.5% drop.
At the peak of the fear in the market ,the VIX (which was calculated differently at the time, ticker is now VXO) hit 55 and 60 in 1997 and 1998 respectively. So far we've hit as high as 45 (using VXO).
Ok, so when you look at the % decline and VIX spike we've seen thus far and compare it to the crises in 1997 and 1998, it suggests there’s potential to go down more but don't kid yourself ... an extreme ovesold market, 45 VIX, put call ratios soaring to the moon and government bonds yields collapsing shows we have massive fear in the market to make a important bottom right here right now. But again, until market action confirms it would be premature to call one just yet.
The best thing to do right now is to be patient and let the dust settle for a little bit longer. All the ingredients for a bottom are there but market action still needs to confirm. It’s not going to surprise me to see 1050-1055 get retested at least once but we are very oversold right now and so some sort of bounce wouldn’t surprise me either. Let’s also keep in mind that the market can in fact go lower as it did in the 1998 and still be considered a correction within a bull market. I still think this is just a correction but if it’s not I’m hopeful I will be able to determine so by carefully observing market action.
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