It has been another violent, tumultuous, whipsawed, and illiquid, 72-hour trading period, with stocks plunging at the end of last week to their second correction of the year from the January highs, only to rebound furiously – and surprisingly – with the Dow posting its third largest one-day point move in history (if far smaller in percentage terms obviously).
The reversal was even more surprising when one considers the growing bearish positioning across all asset classes… well, all but stocks.
As Goldman equity strategist Ian Wright reports overnight, after last week’s pounding, Goldman’s risk appetite indicator (RAI) which at the end of January hit its highest level on record, was nearing neutral levels (Exhibit 1)…
… with the signal from most asset classes that appetite has retreated. However, although equities were the worst performing asset class last week, Goldman’s equity risk appetite signal had not actually fallen, as shown in the chart below:
This, Goldman explains, is because last week:
- (1) EM again outperformed DM and
- (2) small outperformed large caps (Exhibit 3), in part due to the underperformance of tech, which was most likely from political, regulatory and potential tax concerns rather than from poor data about current profitability.
Furthermore, the small vs. large move was particularly sizeable relative to how range-bound it has been much of the past year. The equity signal has also been supported as cyclicals have not actually fallen much relative to defensives.
To be sure, yesterday’s events demonstrated very vividly that in this case, Goldman was right, as it took very little to launch a 669 points surge in the Dow (which has in turn prompted numerous skeptics).
And, perhaps surprisingly, Goldman is among them. As Wright concludes, during the last two low vol regimes (August 2012 to September 2014 and the recent low vol regime starting in June 2016), the bank’s RAI nearing zero has been a reversal signal. However, now that the low vol regime has finally faltered, “it is less clear if this level will trigger a reversal again”, although Goldman writes that the bank continues to not expect a bear market…. even though its bear market indicator is at 71%, a level last seen just before the bursting of the dot com and housing/credit bubbles.
As a result, Goldman reminds that last week it recommended buying correction hedges such as 97/93 S&P 500 put
spreads. It is sticking with this reco. Which, the contrarians will quickly note, means that Monday’s surge is likely to continue, especially since Gartman’s stop-out level is some 40 points higher at 2,710.
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