A Clear Vision of the Markets

The price action in US equities on August 9th strongly suggests that a short-term bottom is in place. After buyers appeared at the open, the market drifted around into the FOMC announcement at 2:15pm. Then sellers tore the market down to a new 11-month low in the S&P. From 2:45pm-4pm, the market then rallied over 6% (!!), finishing the day up 4.7%. While there is no magical formula that reliably catches market bottoms 100% of the time, the most important factor is the activity of buyers. In the downtrend that began in late July, there have been buyers, sometimes very aggressive buyers, at several levels. They appeared for several hours on August 3rd, 5th, and yesterday, August 9th.

The reason that the August 9th buying was significant was due to the aggressiveness, the fierceness of the buyers. There was an all-out rush back into equities for the final 75 minutes of the day, immediately on the heels of a new low for 2011. The market closed at the exact high of the day and had managed to close above the August 8th low as well. This buyers’ rush put an end to the cascading move down in the market. While it is possible that an even larger, scarier move lower is near, the more likely scenario is a continuation to the upside for days, possibly weeks.

Pick your asset class of choice and you can probably make the argument that its price movement in 2011 indicates that the world is imploding. While the markets are trying to keep up with major rapid-fire news (US debt downgrade; FOMC declaration of easy money through mid-2013; Europe backstopping Italian and Spanish debt; etc.), markets tend to overshoot both to the upside and the downside. Since there is an anomalously high level of uncertainty right now across many different strata of market influences (politics, economy, sovereign debt loads, banking system), deleveraging of risk has been the primary reaction by market participants. Because of the existential nature of the problems at hand, the move away from perceived risk and towards perceived security has been extreme. There are now two likely scenarios for equity markets in the upcoming months:

1. Market trades in choppy fashion generally higher, fails to breach the 2011 highs, then heads back down for a test of the August 9th low

2. Market trades in choppy fashion higher for a few days to weeks, then heads back down for a test of the August 9th low

Two outlier scenarios must also be considered.

1. Market rallies in ‘V’ formation back up near the 2011 highs and then goes higher with no test of August 9th low

2. Market continues to drop vertically below the August 9th low

In summary, the short-term looks bullish for equities, the intermediate-term looks bearish, and the long-term is murky but increasingly bearish. One caveat: if the market closes below the August 9th lows, all bets are off and a reassessment is necessary.