Flash-Crash, Mini-Correction... Repeat?
While the decline is being blamed on an Obama win, markets have acted in a corrective way for the past several weeks, and may be warning of a much deeper decline to come.
I don't have a fear of flying; I have a fear of crashing.
-- Billy Bob Thornton
Following Obama's win, markets tumbled and pundit after pundit has been arguing that the stock reaction is proof positive that equities don't like the results of the presidential election. None of this addresses the message of price in the lead up to the elections. As followers of my writings know, I have been negative on risk assets since the end of September as market internals deteriorated. My firm's ATAC (accelerated time and capital) models used for managing our mutual fund and separate accounts, positioned out of stocks and into bonds some time ago, sensing the return of the deflation pulse despite the Fed open-ended QE3 announcement. This been on-going for weeks.
The market has behaved in a corrective way. Take a look below at the price ratio of the SPDR S&P Dividend Index ETF (NYSEARCA:SDY) relative to the S&P 500 (NYSEARCA:SPY). As a reminder, a rising price ratio means the numerator/SDY is outperforming (up more/down less) the denominator/SPY.
When money is afraid of the future, it tends to flow into higher dividend/lower beta stocks under the premise of reducing volatility exposure. Notice the three uptrends and highlighted areas that happened in early 2010 (right before the Flash Crash of May 6), and the move higher starting in April through May of this year as the mini-correction took place. Also note the spike behavior during the Summer Crash of 2011.
The outperformance of dividend stocks over the past month or so is essentially precisely what has happened in prior corrective periods. While stocks on an absolute basis had acted resiliently, this decline may simply be the sudden realization by price that deterioration within markets needed to be resolved. The big question now is if this move ends just like it did in May of this year, or precedes another Flash Crash like move as it did prior to May 6, 2011. I suspect the corrective period is more similar to the mini-correction period and could continue further, but there is always the chance a more meaningful drop takes place.
Nouveaux bulls long for the days of reflation again....
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