As yesterday’s events unfolded there were plenty people saying that they predicted it. In a way we all did. I, for one, wrote a piece in January saying that some areas of the market were bubbly and would pop at some point. Let’s face it, you didn’t have to be a genius to see that, but that article also dealt with the problem faced by traders and investors even as they understood that valuations were getting a bit rich.
What I pointed out was that, while a correction was certainly coming, the bubbly sectors could continue to rise for a while before that happened. In fact it has only been just over three months, but if we take the iShares Nasdaq Biotech ETF (IBB) as a guide, you can see that the problem is the age old one for comedians and those that follow markets alike... timing.
If you had read only the opening paragraph of that January article and shorted IBB or a tech ETF at that time in the expectation of a bursting bubble, you would almost certainly have been stopped out by now. Even if you weren’t, you probably still wouldn’t be showing a profit after a collapse that began in early March.
The point is that even a drop that feels disastrous while it is taking place can look different with a little perspective. These are worrying times for investors who remember the events of 2008-9, or probably more relevantly, of 2000-01, but when looked at in perspective and with a longer term view, this can easily be seen as an opportunity. If we look over the last 10 years a big collapse has happened just once, while corrections of around 4-8% have happened dozens of times. That doesn’t mean we shouldn’t be aware of the possibility of a big drop, it just means that the odds point more to the opportunity scenario.
If we apply that same longer term view (by way of a 200 day moving average) to a 1 year chart of the S&P 500 it becomes fairly obvious that it is not quite time to panic.
I have said before that I am not a fan of complex technical analysis as I believe that often it becomes about showing you how smart the analyst is rather than telling you something useful, but an average of 200 days of the market close is about as simple as it gets. As you can see, in every period of volatility over the last year that simple trend line has provided an approximate level of support. Should this sell-off continue in the broad market, then we will be butting up against that level at around 1800 on the S&P.
At that point I would be a buyer with a wary eye on a sustained break below the average. I am not talking about just touching, or even trading through, the exact average, but rather, if we close below it for a couple of days I would see it as more possible that the drop could continue. At that point I would take a small loss on my new holdings, but from an even longer term view it would just be another period of volatility to ride out.
This in itself becomes easier if we apply some other news from yesterday morning to give some perspective on our current fears. Yesterday, it was announced that the auction of Greek government 5 year debt was hugely oversubscribed and would yield 4.95%. Only a few short years ago, Greece was the problem that, if we believed the constant news coverage, was about to bring down the global financial system. They were a country teetering on bankruptcy and an example to us all of the evils of profligacy... the bond vigilantes weren’t happy. Now, those same bond traders are falling over themselves to lend Greece money at 4.95% for five years.
Part of the problem this time around is that the traditional indicators of long term problems are still unreliable. US Treasuries showed signs of returning to being market-driven, but the recent more dovish comments coming from the Fed could well be responsible for the lower yields we are seeing, rather than any sense of impending doom among those who control the world’s wealth. Similarly, gold has its own dynamic following years of deleveraging and is also responding to the Fed’s words at least as much as to fundamentals. Oil prices have actually risen over the last couple of days which would indicate that traders there are not expecting any kind of economic meltdown.
When signals are mixed and confusing like this, the best things we can do are to look at history and play the odds. The chart tells us that this is most likely to be another correction to around the level of the 200 day moving average, while our memory of the events in Greece should serve as a good reminder that this too shall pass. I am all for staying alert and reacting to news, but stepping back for a little perspective is a good idea before we push the panic button.