Is that all there is? Testing the stamina of a cranky old bull.
Monday's sloppy slide - marking a stark inability of the stock indexes to recover form sharply oversold conditions or to a retreat in the recently surging dollar - was a conspicuous lost opportunity.
But whether Tuesday, when the bond market re-opens after the Columbus Day closure, or later in the week, stocks should gather themselves for a powerful spurt. This likelihood is mostly a function of how stretched to the downside they've gotten under the heavy, erratic selling of recent weeks.
More than 60% of big stocks are way below their 50-day average, the S&P 500 itself is at a widely watched crux siting on its 200-day average and we've just seen a clustering of extreme selling days in which 90% of all trading volume was in falling stocks - something that, historically, raises the odds of decent gains in the days and months ahead.
This chart shows the Daily Sentiment Index of pro traders (blue line) looking washed out, even as the S&P 500 is only around 5% below an all-time high.
If we don't get bounce quite soon, or at least some days of stability, it will represent a failure of the market's homeostasis - the offsetting processes that restore some sort of internal equilibrium when it's gone to extremes. If we fail to bounce, we'll be hearing about waterfalls and cascades and whirlpools and all manner of imagery meant to evoke liquidity in the irresistible grip of gravity.
This would probably involve some sort of financial accident that produces waves of forced selling rather than a collective, sober reevaluation of world economic conditions.
Let's not shy away from calling the recent spill in crude oil a mini-crash. The carnage in U.S. energy stocks as a result is exposing the prospect that domestic shale exploration efforts have been a case of giddy over-investment and not simply the reaping of a lucky resource bounty. Small-cap stocks - proxies for credit conditions and risk appetites - have been under assault since late summer. This market decline is not simply a matter of the froth coming off some over-owned cult stocks in social media and biotech, as we saw in the winter and spring pullbacks.
Currencies are whipping around in ways that suggest lots of capital caught offside in riskier parts of the world and seeking escape. In some respects in feels like 1997 or 1998, when currency and emerging-market panics caused 15% to 20% dumps in big U.S. stocks even as the domestic economy held up just fine.
Yet even as all this swirls around, let's say we get that bounce - a couple percent in a day, up 4% in a week, or whatever it looks like. What then? Would it serve as an all-clear this time the way 5% to 7% setbacks in the S&P 500 have reversed to new highs rather quickly and effortlessly since 2011?
Maybe Fed officials' acknowledgement over the weekend of the deflationary, growth-sapping effect of a stronger dollar and slumps in Europe and emerging economies will do the trick again.
One could argue that the nasty bloodletting beneath the surface of the big-cap-indexes has gone a greater distance to resetting valuations of the average stock to more reasonable levels, I suppose.
The character of this decline has been different enough, though - and has been accompanied by more jarring global shifts - that it's worth asking if we're in for more than another cheeky little correction.
Could this, dare I ask, be just about all the bull market has to give us?
I don't know, and nobody else does.
The burden of proof for the past two years has rested on the skeptics. The main risk for more than two years has been in over-thinking it rather than simply accepting that plentiful liquidity and profitable companies and compressed volatility meant "buy risk."
There's some reason to believe the main risk is shifting toward under-thinking the implications of a starkly unbalanced world with the possibility of (slowly) tightening money facing a richly priced risk-asset market.
Could it possibly end in such a scripted, neat-and-tidy way?
Is it plausible that the mighty bull market, which started 67 months ago, will have reached its ultimate top on the very day of the largest, most overhyped IPO in history, and just as the Federal Reserve’s bond-buying binge was expiring?
Was the apex perfectly synched with a leading venture capitalist’s charge of bubbly excess in Silicon Valley, a Chinese company buying the Waldorf-Astoria for $2 billion and as “Turn Down for What” peaked as a hit song and trendy roar of defiant invincibility?
Markets do tend to have a mischievous sense of irony – and traders and Wall Street wags trying to sound cool and clever know this. So Alibaba Ltd.’s (BABA) $25 billion initial stock offering on Sept. 19 was greeted both with overripe hype and simultaneous catcalls from the wised-up self-styled contrarians that it would mark the top.
Does the prevalence of predictions of an "ironic top" indicator negate the chance that such a top has been put in. Or, have the top-callers been "wrong enough for long enough" that market karma is now working in their favor?
No one can say. What's clear is that some payback is being extracted from last year's effortless melt-up. Exactly two years ago, I suggested that the "era of uncertainty" that enveloped the post-crisis market was nearing an end. Not long thereafter, investors finally internalized the idea that central bankers had cushioned the world against imminent return to the abyss and were supportive of markets; Congress had done all the harm it likely would; and the economy itself finally began to recover lost ground in a persuasive manner.
Stocks ramped, valuations expanded, and the S&P 500 surged exactly 50% from the post-2012-election liftoff to last month's high. That "liftoff phase" left us at levels that required evidence of true organic growth and other central banks picking up the baton in their regions if they were to hold. We're now experiencing the anxiety of seeing whether they will.
I argued much of last year that while the bull market was not young, it was an unusually battle-tested one, having absorbed 15% and 19% downside shocks in 2010 and 2011. Arguably, the bliss of 2013 wore away that grittiness and made the Street too used to peace and calm.
It's understandable that investors would get uneasy around the end of the Fed's quantitative easing program this month - even though the economy seems able to handle it and just months ago consensus said an exit was overdue.
Historians remind us that when younger American soldiers near the end of World War II heard that FDR had died, they were profoundly shaken - they remembered no other president and weren't sure whether or how they should continue to fight. This, perhaps, is how investors are feeling as the end of hyper-easy money comes into view. The last Fed rate increase was in mid-2006. After FDR's death, the country was fine and the war just about won. But how could a citizen-soldier who'd known only one leader take that for granted?
Still, the U.S. economy is unequivocally in better shape now than after QEs 1 and 2. Here are the two charts I'll watch with particular attention in trying to figure out if the next bounce is durable, or if the next down leg is substantiated by genuine economic deterioration.
Junk-bond spreads have been both beacon and tugboat for the equity bull market. They have turned higher from quite-low levels, which puts downward pressure on equity valuations (even if earnings come in as hoped). That can't go on much longer if stocks are to get their get back under them.
And here's a broad look at the strength of financial conditions. Lower on this chart is better, indicating freely flowing liquidity and very little stress in the system just now. That's good, implies we have a decent cushion against shocks built. Unfortunately, this index can go vertical on short notice, as seen in 2007 - but we're not yet feeling strong tremors that it's about to again.
If forced to bet, I'd say this ongoing gut check has the greatest chance yet to turn into a panicky, cleansing correction at least, rather than the abortive, incomplete corrections of the past couple of years. Then again, we're about to enter a nice seasonal stretch for stock returns and we're heading into it in textbook oversold fashion.
Let's watch how things shake out on that next bounce.
