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FBN Warns Not All Pullbacks Are Created Equal

Via FBN Securities' Jeremy Klein,

In a secular rally, pullbacks will inevitably arise.  Market participants, though, should not view all drops in the same light.  In addition to the differences in the depth of the collapse, the magnitude of the changes of critical investor sentiment statistics may differ greatly.  Hence, identifying a potential trough with the use of a nondiscretionary quantitative trigger may not prove reliable.  Nevertheless, recognizing the amount of aggression contained within each selloff can be invaluable in forecasting a fortuitous buying opportunity.

I identified fourteen material declines for equities since July 2007.  Traders did not have the ability to short a common stock prior to this date.  I leveraged the following technical indicators for the study:  average session range, range as a percentage of index level, average monthly NYSE closing TICK, average monthly NYSE intraday TICK, the number of TICK readings below -1,000, average miles driven, miles driven as a percentage of index level, ratio of miles driven to range, open interest in the futures over the past week, volumes in the E-Minis, notional value transacted in the E-Minis, and relative performance between the Russell 2000 and S&P 500.

Unsurprisingly, the drops associated with the financial crisis and the sovereign credit downgrade of U.S. debt ranked as the most violent over the period investigated.  I actually assess the slide that climaxed in August 2011 as more extreme than the beating share prices received in the wake of Lehman’s bankruptcy albeit this distinction is nothing more than splitting hairs.  While painful at the time, pullbacks such as the one that resulted from the fiscal cliff negotiations or the “taper tantrum” were mild in comparison.

Assessing the current retracement is a difficult prospect as we may have yet to reach its terminus.  Based on the initial sentiment statistics, the decline has more similarity to the aforementioned historic collapses.  Specifically, this most recent selloff scored highly in nearly all categories including the mileage driven, session ranges, the TICK averages, notional volumes, and the scale of underperformance exhibited by smaller capitalization names.

However, I do not anticipate that we have stumbled upon a full blown bear market but suspect that a bottom still sits in front of us.  The lack of any upward inertia in the open interest figures supplies me confidence in such an assertion.  At a minimum, institutions create 165K contracts over the previous five days when suffering from rapidly falling share prices.  Moreover, this metric usually climbs above 250K on these occasions and peaked at roughly 950K for the August 2011 correction.  Using the preliminary data from yesterday, the corresponding number computes to only 99K.

Consequently, portfolio managers have stubbornly refused to throw in the towel. 

I maintain that most firms desperately cling to the hope that the broader indices will enjoy a breathtaking rally as the calendar moves toward Christmas.  Reducing one’s exposure would constitute a forfeiture of the year such that investors who have struggled in 2014 are loath to lower their risk.  Thus, capitulation gets delayed which allows me to reiterate my bearish outlook even as the S&P 500 dipped to within 25 bps of my official target on Monday.

The macro data remains quiet until tomorrow to accentuate the impact of earnings which starts to build momentum this morning.  The usual swath of money center banks will provide their results over the coming days while INTC will hog the headlines tonight.  Although I do not expect a poor reporting season, the Fed has gifted corporate executives an excuse for any shortfall with its concerns over the strengthening dollar.  Any help from these announcements will therefore be modest at best.

S&P 500 Cash Key Technical Levels

Support:  1874.00/70.00, 1868.00/65.00, 1862.25/60.00, 1850.50, 1846.00/44.00, 1816.25 , 1800.00

Resistance: 1887.25, 1892.25, 1905.00, 1909.00, 1912.00, 1929.00, 936.00/37.00, 1938.50/1942.00, 1959.25