No Trend Reversal, Market Trading Action Continues To Be A Historic Outlier

Some good commentary out of Lehman's Matt Rothman released yesterday. The squeeze is merely the last method available to prevent the trend from normalizing.

As we highlighted in our note of Tuesday, April 14th, we were concerned about an impending reversal in the underperforming Sentiment Theme index and the outperforming Valuation Theme index.

Yesterday [Monday April 20], we started to see the beginning of reversal in the manner that we expected: the Market Sentiment was up 9.1% and the Valuation Theme was down -3.5%. Placing these returns in historical context, yesterday's Market Sentiment index return the best ever single-day return measured back to July 1950 (out of 14,860 days) while the Valuation Index's return was the 6th worst ever. Thus, we believe the reversal trend is currently well under way. [TD: Tuesday and Wednesday market action has completely refuted this.]

We expect this reversal to continue. As we have previously stated (see our note from July 2, 2008), historically, reversals tend to occur at 2 to 3.5 times the speed of the build-up (peak to trough) and destroy approximately 60% to 75% of the value accrued during the build-up. One day isolated reversals are rare [apparently not when you have "additional" factors involved]. We expect today's reversal to continue along well-established historical lines.

The previous rally was driven primarily by beaten down, cheap, low priced stocks of questionable quality. An equally weighted portfolio of stocks that had prices under $5 as of close on March 9th had generated a positive return of 128.5% through April 17th, outperforming Russell 1000 by almost 2.5 times (Russell 1000 return for the same period was up 52.6%). Similarly, an equally weighted portfolio of 100 stocks with the lowest Market Sentiment score as of March 9th, yielded 116.7% during the same period. Today, these portfolios reversed strongly, experiencing a –10.9% and –11.6% returns, respectively, while the index was down only 4.4%.

Several individual factor also experienced historically significant returns. Specifically among Valuation factors, Book-to-Price lost -6.6% today, its largest one-day loss ever, and Sales-to-Price lost -5.1%, its 6th worst daily loss ever. Conversely, all of our Market Sentiment factors rallied today with many generating historically significant returns. Price Momentum returned +6.9% today, its 4th best daily return ever; Abnormal Stock Liquidity yielded 6.5%, its 2nd best daily return; and Market Estimated Earnings Surprise had its best ever daily performance of 5.1%.*

Again, we expect today's trend to continue over the next 1 to 2 weeks, during which time it will erase 60% to 75% of the prior rally, assuming history is any guide to the future.