Are we going to crash?

by Jay Pestrichelli on August 22nd, 2013

In every client conversation I had yesterday, the same question kept coming up. “Is there an imminent crash around the corner?” And while it is a legitimate concern for any investor, it should be less of a concern for those that hedge. We’ve always said, timing the market is a difficult thing to do and even if you’re very good at it, one wrong move could be devastating. That doesn’t mean we ignore what is going on. There are times we put on our fundamental or technical hats and make general statements as to how we’re positioned. Here are a few things we’re tracking on that front:
Option Premiums
Hedging is best to do when markets are high, as it is less expensive and less of a drag on gains. It’s similar to how drivers with a good record pay lower car insurance rates. The same concept applies to the stock markets; that lower risks get the benefits of lower premiums.  So looking at premiums is one way to determine how much risk the market is assigning to a crash. We talk about the cost of hedging on a weekly basis on this blog and it is a way for us to keep track if the premiums to put on protection are high or low. Right now, they are clearly trending higher, but no one is hitting the fire alarm just yet.  

We also look at the skew between the calls and puts spreads for our high probability credit spreads. That hasn’t shown us any indication of a notable bearish move in our near future. The probability of the market moving higher from here is significantly greater than it moving lower.  Again, it doesn’t seem as if there is a Panic! At the Disco (sorry for the obscure reference)

We posted in the beginning of the month that beats were coming in on pace and despite the low level of growth, companies are beating expectations. Read it here.

Technical indicators
Here’s where it starts to get a little fuzzy. From a technical perspective, there are many instances where the indexes have failed to hold at their support levels and the 50 day moving average; both of which are bearish signals.  Then there is the rare and obscure Hindenburg Omen that has reared its head. For more on that here is a quick video explanation.

However, those watching momentum indicators will tell you that the market is oversold and poised for a rebound. The RSI, for example has actually crossed up over the 30 line which is a bullish signal. The CCI is also showing characteristics that have been associated with upward movements.   
When it comes to reading charts, we try to keep it simple. If we get higher highs and higher lows, then we in an uptrend.  Since November 2012, there is no doubt that is the case.
Interest Rates
The stock market has become linked to the bond market and interest rates because of the Fed’s action and the availability of inexpensive money. It is uncommon for bonds and stocks to move in correlation, but stranger things have happened. Presumably once the Fed can get out of “bail out mode” with a stronger US recovery, we can get back to a normal correlation between bonds and stocks. However, that is not the world we live in today, so we have to recognize that. If the interest rate trend continues, then expect the equity markets to continue to feel pressure as interest rates rise.
One way to follow the 10-yr rate is through TNX. Interesting chart and is clearly in an uptrend. 
Boil all this down and despite the way August feels to all of us, there’s nothing to support a doom and gloom scenario. Perhaps we get a little more of a pull back, but nothing too worrisome. Our advice: stay hedged, don’t time the market, watch for a slow but steady recovery over the long run.

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