Too many people are worried – there is plenty of bad news that has surfaced. Today, May 20, initial claims had risen by a much more than expected amount, suggesting that the domestic labor market is still a bit murky, contrary to data a few weeks ago. The S&P 500 Volatility Index has been breaking out, well above 40, thus confirming that investor ‘fear’ is now among us – too bad I did not straddle VIX options. To carry on, Government pipelines are filled with new regulations and the only thing investors seem to really care about right now is the euro zone crisis.
Those who bought domestic equities while the U.S. economy was in recession not too long ago clearly overlooked the uncertainty and saw opportunity. 12-16 months ago, individual stocks were just too discounted to simply ignore. The U.S. equities markets today are roughly 10% off their recent highs. Now I assume that with a correction, which has been anticipated, there must be some bad news to fuel it. If there is no bad news, besides modest profit taking, what else could cause a 10% correction?
With all the data out there that can easily influence retail investors to sell their U.S. equity positions, which I do think could be a mistake, I decided to do a simple analysis to provide more paint to the picture. My analysis is as follows:
Consider March and September of 2008, when Bear Stearns was sold to JP Morgan (JPM) and Lehman Brothers declared bankruptcy, respectively. For every day that the Dow Jones Industrial Average closed down in those months of March and September 2008, on average, the index had closed 98 and 91 points above the intraday lows, respectively. The Dow Jones so far for May 2010, in the midst of all these new worries, for every down day has given back roughly 140 points on average from the intraday lows.
This analysis implies that investors are not giving up on the market. Yes we see volatility and bad news floating around, but on such down days, we do not see aggressive selling into each day’s close (not considering today). Note that options expiration is tomorrow and that easily could have pushed the markets to new daily lows at the close today. I say that because I postulate many investors bought put options in the wake of Europe's problems, the oil crisis in the Gulf, and new regulations, but those investors were hesitant to outright short companies due to the fact that we were (or still are) in a bull market. Therefore, a bias towards the downside today and potentially tomorrow seems justified.
I will have to follow up to this analysis when May concludes, nevertheless, I feel that investors are using each down day to buy more shares of U.S. equities – to position themselves for when the upward trend in the market resumes.
Full disclosure: Long VIX Puts at time of writing.
