Major averages moved higher yesterday on lower volume after the last two day drubbing. Damage done to leading stocks is pronounced and is reminiscent of prior market corrections where an initial 1-2% pullback over a couple of days in the major averages would lead to much deeper damage among leading stocks. Earlier this year, initial damage was considerable and led to the deepest corrections among leading stocks since QE began in full measure in January 2013. That said, with an imminent changing of the QE guard on the horizon, this initial damage could worsen in at least the short run, and with futures down sharply this morning as reality bubbles back up to the surface in Europe, this is starting to play out in real time.
So while markets kept calm yesterday after the minutes from the June FOMC meeting were released, the level of complacency was a red flag, and today, markets seem to be having second thoughts. Within those minutes were Fed concerns about the low volatility complacency seen in the markets as they continued to reach new highs over the past few weeks implying that investors aren’t factoring in a more hawkish central-bank approach.
Assuming the economic recovery goes as planned, the Fed will end its bond-buying program in October. That said, the Fed has said it will keep rates near zero for a "considerable time" which implies some form of market manipulation. While the market expects interest rates to be kept low well into 2015, Pimco's Bill Gross, manager of the largest bond fund in the world, has said he expects low rates well into 2016 due to a lackluster economic recovery.
So given this, the long term uptrend could remain intact, but a correction of the magnitude seem earlier this year is entirely possible. Complacency is also observed by the latest survey of Investors Intelligence newsletter writers which showed a rise in bullish sentiment to 60.6% from 57.6% last week. The bulls-bears spread stands at 45.4% which is the highest so far this year. Such complacent bullishness can act as a contrarian signal.
It is best to keep stops tight in such an environment. Selling and moving to the safety of the sidelines or establishing short position in logical areas can also be prudent.
Given all of the the above, the Market Direction Model and UVXY Model are both heading to cash this morning. UVXY's latest signal reaped huge gains, and as we have stated before, one can take profits when certain percentages are reached, while trading around a core position.