WHEN WILL IT END!? Soon...?

Gordon Scott |

The serious market sell-off may have come to an end Wednesday. While there still may be more selling yet to come, it may become more choppy with a more even distribution of buying and selling days.  In fact, we may even see the market put in a bottom somewhere between the current levels and the 1000 mark on the S&P 500 cash index. Why would I say this? Why would I discount all the talk of double dip recession doom and gloom? Well I can't deny things look bad right now. All the predicted worse-case scenarios could still happen. But conditions always seem to look their worst at the bottom of a market downtrend. Looking around I see plenty to worry about. But I also see some evidence to the contrary. Things that could lead to the market stemming its tide and preparing to reverse. First off, recall that last week brought THREE good news reports for jobs. ADP and Non-farm Payrolls reports were better than expected. The weekly jobless claims number was down sitting right on the much-watched 400K fence (a number lower than this means improving economy). This was good news that the market ignored in its panicked race for the theater exit. After all, when performers start yelling “fire” from center stage, the audience tends to ignore all other evidence.  Fundamentally, the economic signs of a recession may not be as substantial as some want you to believe. The technical evidence is eye catching also. Consider these charts, first the 10-year note (TNX), and second the volatility index (VIX).

The rally in bonds is a bit counter-intuitive. You would think that if the U.S. is downgraded from its triple A rating, that investors would consider the country’s bonds to be more risky and would not want to hold them unless they command higher interest rates. But since interest rates are falling fast and likely to be held artificially low (at least until mid 2013 according to Mr. Bernanke), there is very little interest rate risk. Bond holders will need to get out of their current low-yield bonds to buy better interest rates later. Since interest rate risk exerts a stronger influence on bond prices than any other factor, removing the fear of rising rates means bond prices should soar—just like they did over the past two weeks. But the 10-year note has now reached a critical level.  In fact, Wednesdays close is very near the two previously lowest weekly closes back in 2008.  From here, it could be the case that interest rates could begin to rise. That would me the money stops fleeing into the bond market, and instead returns to the stock market. Tentatively at first, of course, but once the selling frenzy lightens, buyers will be emboldened and the tide may turn.

For a point of confirming evidence, consider that the VIX hit a lower high on a day when the market put in an equally low close (comparing Monday and Wednesday).  If this is a sign of diminishing fear, then it might be a timely one for savvy traders to notice.

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