Thursday, August 09, 2007

Swim At Your Own Risk

Watch your back.

One day after the NASDAQ saw its heaviest volume in 2007, the NYSE saw its heaviest trading volume ever. While historical extremes can suggest an exhaustive climax is in progress, this is hardly a foregone conclusion.

Distribution has a long history of killing young rallies, and Investor's Business Daily points out a sobering statistic. The market has seen heavy selling within 3 days of a follow-through session 14 times since 1982. 13 of those 14 times, the rally ultimately failed.

Unfortunately, leading stocks aren't suggesting that this losing streak will be broken. While the NASDAQ shed 2.2%, the IBD100 tumbled 4.7%. Also, after improving some on Wednesday, IBD100 internals weakened on Thursday. 91 of 100 stocks closed lower, while 35 stocks saw distribution. In truth, it's a little surprising that the distribution wasn't heavier on so large a price move with such terrible breadth.

The market is so unstable that short-term predictability is difficult. While further downside seems obvious, the chart below shows that the NASDAQ is also printing a variation on a bullish inverted hammer. It's been approached unconventionally -- and the reliability is low/moderate anyway -- but in this crazy, volatile market, it's best to keep all the cards in front of you.

The odds continue to point to an eventual test of Monday's low. However, the second-highest NASDAQ volume in 2007 produced just a 2.2% slide, which neatly closed the gap in the process. Also, after 7 billion shares changed hands in just 13 hours, the NASDAQ is off a scant 5 points (0.2%). The evidence suggests there's a stealthy bid under this market, but Friday is a whole new day.

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There's also more to the credit situation than meets the eye. For now anyway, the broader credit markets don't show the histrionics seen in the mortgage-based areas. In an article on Thursday, Tim Rogers at clarifies the distinction between liquidity demands and a credit crunch, and notes that, while gnarly and unpleasant, both systems continue to function normally.

There is an undeniable need for global liquidity, which the various central banks are responding to. However, Rogers notes that for now, only a small number of commercial banks (4%) are tightening commercial and industrial lending standards. This contrasts with the 60% that did so during the 2001 peak. Rogers writes:

There is no evidence yet of a credit crunch, only the need for cash to stand in for the subprime assets less able to be valued and used as collateral.

The performance of the bond market continues to corroborate Rogers' findings. Below are comparative charts of the 10-year Treasury, high-grade corporate paper and junk bonds that I posted a few days ago. These continue to hold up, as the broader, non-consumer credit market shows some welcome stability -- for now anyway.

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Also, both yield curves are now positive, as the bond market still has doubts about the "certainty" of a US recession.

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As counterintuitive as it may sound with so many stocks hitting New Lows, growth continues to outperform value. Not only does ELG continue to outpace ELV (see chart), semiconductors were the best performing group on Thursday.

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The VIX vaulted 23% to another 4 1/2-year high as the price for an equity prophylactic continues to be no object...for now.

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The effects of the credit nightmare are accelerating at the same time that bottom indicators are strengthening. If history is any guide, the growing tension between these two is likely to release itself when everyone least expects it.

Friday should be another doosey. See you then.




Becky said...

dk, I love your blog SO MUCH! It's the first thing I read in the morning. The quality of your information is right up there with Barry Ritholtz's The Big Picture blog. Thanks so much for writing it!

dk said...

Thanks, Becky. I appreciate your comments, and hope these posts help.

marketreflections said...

dk, your report is great, and a must read for me.

the 2-10 yr yield spread

2 yr yield now: 4.41
10 yr yield now: 4.75

the spread (10yr minus 2 yr) is 34 bps, so how to read your yield spread chart? Am I missing something? thanks

dk said...

Hi market...thanks for the comments. Regarding yield slopes, to make sure I'm tracking apples-to-apples, I track ratios (not differences) between the various durations. Below 1.0 is a positive (good) slope, and above 1.0 is a negative (bad) slope.

FYI -- as I write, the shorter 3-mon/10-year that economists prefer as a recession warning has become steeply positive, which is good. However, EOD is all that matters. Hope this helps.