This report was issued by Standard & Poor's Equity Research Services on Oct. 24
Stock market futures were limit down during pre-market trading this morning, as markets around the world crashed overnight. The last time we saw this type of premarket activity was a brief time on January 22, and, of course, on 9/11 and during the crash in 1987. These circuit breakers were instituted after the ’87 crash and were instituted to prevent another crash and let cooler heads prevail. Whether they work this time is anybody’s guess. Maybe this type of price action is what we finally need to clear the decks, wash things out (even more), and help create some type of tradable low. But we just don’t know.
Global markets got crushed overnight with the Nikkei plunging almost 10%, the Hang Seng over 8%, the FTSE almost 8%, and the DAX almost 7%.
The reasons for the latest weakness are some very weak corporate earnings reports overseas and worries about the meltdown in the global economy. This has led to continued selling by institutions as they are forced to raise cash. We look for some major action by the government like further cuts in interest rates, more stimulus packages, and if things really get out of hand in the equity markets, a trading halt for a day or two or possibly longer.
Also, don’t be surprised if the government intervenes in stock futures, which they have done in the past to support cascading prices.
Technically, the S&P 500 undercut the October 10 closing low of 899 earlier this week and is rapidly closing in on the 10/10 intraday low of 840. Below this, the next support is the October 9, 2002 bear market low of 777. Quite frankly, we think we are in a panic mode, and when this occurs, technical and fundamentals become less meaningful. While we will not know at what P/E the market may bottom, or at what technical support it may hold, we think a bottom will be signaled once consistent demand from institutions starts to emerge. As we have been saying, we also think there is a decent chance of a very large move to the upside once a bottom has been reached, given that the market has gone virtually straight down, and that there is little overhead resistance on the way back up.
If we are unable to hold the prior bear market lows at 777 on the S&P 500, then things get even cloudier (if possible). There are not any major layers of chart support to speak of beneath the 777 level, at least for a long way down. There is, however, a very long-term trendline off the 1932 lows that comes in between 600 and 700. First off, because this line is so long, it does not match up perfectly with some of the major lows over history, so where it is placed becomes somewhat subjective.
Secondly, determining an exact support level from this line is very difficult, because +we do not know if the “500” will fall directly to this support line, or if we get there many months from now. Therefore, we have given a wide range for this potential support from 600 to 700.
We have said in the past that once an index retraces more than 61.8% of the prior bull market, it is then very susceptible to a full retracement. Sam Stovall, S&P’s Chief Investment Strategist, took this analysis one step further in the hopes of pinpointing a potential bear market bottom. He looked at all the instances where the S&P 500 retraced over 61.8% of the prior bull market and then measured how much more damage had occurred. During the 1929 – 1932 bear market, the “500” retraced 108% of the previous bull market. The 1938 to 1942 bear saw a 119% giveback, the 1968 to 1970 decline retraced 111%, while the ‘73/’74 collapse resulted in a retracement of 114% of the prior bull market. The one instance when the “500” gave back more than 61.8% of its previous bull market and did not retrace a full 100% was the bear market of 1937/1938 when the index gave up 96%.
Averaging all these occurrences gives us a retracement of 110% and that would equate to a move to 700.
Volatility indices spiked this morning with the VIX (options on the S&P 500) surging to almost 90%, the VXO (options on the S&P 100) to 86% and the VXN (options on the Nasdaq) to almost 87%. These are extreme readings, but these are extreme times. Put/call ratios on an intraday basis are fairly elevated today something from a sentiment standpoint that has been missing during the recent selling. At this point, we would like to see a hard bottom with prices closing near their lows today, a sharply lower open Monday, followed by a large upside reversal. However, what we want and what usually happens are two different things.
Crude oil as well as most other commodities have plunged due to the quick downturn in global economies, unwinding of speculative bets, forced liquidation, and a huge rally in the U.S. Dollar Index. While this hurts if you are invested in commodity stocks, it certainly reduces input costs for corporations and acts like a huge tax cut for consumers. The catch 22 part of this is that commodity prices are falling in part because of a weakening global economy, but it may be prop for corporations and individuals alike, and soften the impact of previously high prices. Everyone thought $100+/barrel oil would cause a global recession. However, perhaps sub-$70/barrel crude oil will act as a buffer for the global economy.
Technically, crude has dropped into a wide area of chart support between $55 and $70/barrel. Long-term trendline support, drawn off the 1998 bottom, comes in around the mid-$60’s. Prices, which were almost 50% above the 65-week exponential average in June, are now almost 33% below the 65-week average.
Clearly, the oil market has gone from an extreme overbought to extreme oversold position in just five months. The markets are sometimes like a rubber band, and the oil market as well as equity markets seem stretched to the limit right now.