David Rosenberg On Market Capitulation And How This Short Covering Squeeze Will Play Out
In light of continuing deterioration in macroeconomic data (we don't remember when the last time was that we had a materially better "than expected" data point) many are left wondering how it is possible, that when seeing broad signs of capitulation even among the permabullish contingent, the market has resumed its ceaseless levitation. Simple - as David Rosenberg recaps our post from two days ago, "Short interest on the NYSE and Nasdaq surged nearly 4% in the second half of August; these positions are now being squeezed, which is the "buying" support" the market has been experiencing in the low-volume rally of the past few sessions." Indeed, as long as the weakest hands who piled on the shorts into the latest market plunge are not cleared out, the current episode of no-volume levitation will continue. Sprinkle one or two favorable headlines which sends the robots into a frenzied bullish bias churn, and one can see why it may be time to whip out Birinyi's ruler.
MORE SIGNS OF CAPITULATION?
- The USA Today consensus showed that strategists have cut their year-end S&P 500 targets by 8%.
- Wall Street economists are at 40% recession odds, which means if the heads of research allowed them to really say what the probability was it would be 80%.
- Bank of America let its chief equity strategist go who was calling for 1,450
- on the S&P 500 and the most bullish seer out there (we wish him well).
- The AAII investor sentiment survey shows 30.2% bulls and 40.3% bears.
- The Investors Intelligence survey also did a switcheroo, with the bull camp in the past week down 3.2 percentage points to 35.5% and the bear share rising the same amount to 40.9%. That is the largest number of bears since March 2009 (was 21.5% at the July market peak). And we have the fewest bulls since the August 2010 retest of the lows back then. The "spread" is now -5.4% between the bulls and bears, well off the +28% gap at the July market peak.
- Short interest on the NYSE and Nasdaq surged nearly 4% in the second half of August; these positions are now being squeezed, which is the "buying" support" the market has been experiencing in the low-volume rally of the past few sessions.
Remember, it is not at all unusual to see the stock market enjoy a relief rally after the initial 20% leg down in a cyclical bear market. For example:
- The S&P 500 peaked on September 1, 2000 at 1,520. By April 4 of 2001 — the economy at this point is more than a month into recession — it hit an interim low of 1,103. Then even with a very poor economy, the news became less bad, the shorts covered, and the S&P 500 zoomed ahead to 1,312 by May 21st. That was a 19% surge despite the economy moving deeper into recession.
- How can that be? Well, that's how the market works — backing and filling. But the right strategy was to continue to adopt a recession view until the data told you to abandon that view and to sell into that strength. By September 7th, two days before the 9-11 terrorist attacks, the S&P 500 had broken to new cycle lows of 1,085 (and didn't hit the ultimate low of 776 until October 9, 2002).
- It was the same deal in the last cycle. The S&P 500 peaked at 1,565 on October 9, 2007 and then endured a big initial leg down to 1,273 by March 10th — when Bear Stearns went bust. Then, after a series of Fed rate cuts and a huge tax rebate from Washington, that's all it took to scare the shorts and took the S&P 500 all the way up to 1,426 by May 19th for a nice 12% bear market rally. By the end of July we were back below 1,250 and that was before Fannie and Freddie had to be taken over explicitly by the government ... and we know what happened after that. Indeed there were plenty more peaks and valleys before the trough was finally turned in (in March 2009).
- We had this similar pattern in the early 80's as well — the S&P 500 went from 140.4 on November 20th, 1980 to 112.8 as of September 25th, 1981 — that first 20% leg down — to only then get a relief technical rally from oversold levels to 126.3 by December 4th, 1981. That got a whole lot of traders excited but the long-only crowd got decimated unless they got out at these better price levels because the S&P 500 ultimately went all the way down in the last down leg to 102 by August 1982.
- Moreover, back in the mid-70s bear market, much of the same. The S&P 500 slid from January 11th, 1973 from 120.2 to 100.5 as of August 22nd, 1973 so we had that first 16% drop. That was followed by a nice rally back to 111.4 by October 26th, 1973. The trough, however, was 65 at the lows in December 1974.
- In all cases, that first rally following the initial leg down reversed half of the initial selloff. That is exactly what is happening right now. Tread cautiously if you are tempted to jump in. In other words, even with the bounce off the early August lows, this cyclical bear market is following a very similar path.
Source: Gluskin Sheff
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