Sharp Correction in 2014?

[Gary 20]

I know we have a lot of strictly non-directional traders here... just wondering if anyone is exploring the idea of a medium-term downside bias in 2014. I usually don't have any conviction about market direction one way or the other, but lately I've seen some data points suggesting that we're at or near a market top.

 

It started with a video I saw a few weeks ago on tasty trade. The segment took a look at the 5 secular (long-term) bull markets since the 30's (including the one we're in). So far, all of these markets ran for 54-59 months and ended in a sharp decline of 28-54%. The current bull market started in March'09 and is 57 months old. Click here to see the video.

 

Another indicator that I like to keep an eye on is the Value Line Median Appreciation Potential (VLMAP). VL takes their standard universe of ~1700 stocks and estimates 4-year appreciation potential for each one. The MEDIAN figure is currently 30%, or ~7% per annum. This number has historically been a pretty good indication of market bottoms and tops. To my knowledge, 30 is the lowest figure seen in many years. I believe the lowest it's EVER been is 25. I'd say 80 is a "normal" figure, while market bottoms can see numbers in the 150-200 range (March'09 was 185). If the market goes even 5% higher this figure will be in unprecedented territory. There are successful trading services that use 50/100 as trading signal thresholds for VLMAP.

 

Another data point that would seem to support a sharp correction was mentioned in the tasty trade video. It's "net free credit" - i.e. total margin debt less the cash available in cash and margin accounts to cover margin calls. As of November this figure was at NEGATIVE $130 billion. This means once a correction starts it will likely be exacerbated by margin covering for a while. It's not perfectly clear whether the margin is being used mostly for bullish bets, but with the index put/call ratio at 0.64 (as of Tuesday) and the direction of the market recently, it seems there's a lot of bullish betting going on. I'll attach a spreadsheet showing the calc.  net_free_credit.xlsx

 

I'm curious to get other thoughts on this. At a minimum it seems fairly evident that we should not expect the whole of 2014 to be like 2013 was... volatility could be higher, and there could be some sharp moves.

[Kim 7,943]

Gary, those are very good data points. Personally, I can say that I stopped trying predicting the market direction long time ago. So I'm not going to try predicting what is going to happen in 2014, but what I can say is that I'm pretty sure that we are not going to see a repeat of 2013 in 2014. The markets really look overstretched at those levels. 

 

Just to put things in perspective, RUT is up 230% from March 09 bottom - that's less than 5 years! TWTR is trading at x70 next year sales!! If this is not a bubble, the I don't know what bubble is.

 

So yes, I think those who are long equities should be supper cautious at those levels and think about some protection, especially now when protection is super cheap. Anchor trades can be a perfect fit for those who still want to be long but also want some protection. 

[Marco 223]

would agree that market looks toppish and there are many 'red flags' around. However you could have easily made the case 10-15% lower. The problem with bubbles is that it is VERY hard to pick the top. So I'm not having a short bias but I'm trying to add some long gamma trades and a bit of protection to my portfolio and maybe open a proper short position when there is more evidence that the bull trend is broken.

[dbh21 62]

I read a lot and I see people on both sides of the fence. Many economists think there will be a significant pullback, but not until 2015. Porter Stansberry pulled all his money out of the market and is expecting a correction in the first few weeks of January. Steve Sjuggred is predicting the market will go up from here - not because it is warrented, but because at this point the mom-and-pop retail investors are entering. Mauldin and many others don't think there will be a correction while there is cheap fed money still available, but when it occurs, it will hurt. I think Rosenburg is still bullish (mostly due to the Fed). Harry Dent (I don't put a ton of weight in him) predicted the market would start crashing 5 months ago.

 

The general consensus I get is - there should be a correction as the market is up on weak data - but there will not be one for a while. Based on the market rally on the Fed announcement, I'm trying to figure out if we are in a good-news is good news environment again. Otherwise, who knows.

[Gary 20]

Yeah I agree there are a lot of mixed signals and that it's usually a fool's game to listen to them. It's just that there are several indicators with good long-term track records that are pointing to trouble. I think outright directional bets would be very speculative, but this information can still be helpful ... for example, we might want to be careful about "over-reacting" to the underperformance of certain strategies in 2013. I think 2013 was a very unusual year, and 2014 promises to be more interesting.

 

BTW I'd be really surprised if 2015 was a bad year. We haven't had a negative pre-election year in the Dow since 1937. This is actually another reason why I think the market is poised to let some steam out in 2014.

[PaulCao 51]

Hi, 

 

My plan is to keep my long term investment in ETFs but further contribution to accounts will be in money market; and when the correction comes, I plan to dollar average SPY with the saved cash all the way down. I am too stupid to predict the market, so have to use dollar averaging if it means that I might not be able to time the bottom optimally. 

 

Best,

PC

[cwelsh 1,549]

I've been expecting a large pull back for some time -- and I'm still waiting.  I still stay by the premise of don't bet against the Fed.  Even though they are taking some QE off the table -- they're not taking much and if the markets start to crack, I wouldn't be surprised if they gunned it right back up. 

 

So what does this mean?  Well I think the markets are due for a pullback,I just don't know if the Fed will let them.  E.g. I don't really know what's going to happen, so will largely continue to avoid directional trading.

[Guest Peticolas]

Gary. You may have a point but be careful about being early. Looking at a chart of the S&P 500, a bull market is still clearly in place ... strong uptrend, above all medium term moving averages, shorter term moving averages above longer term moving averages, etc.  Trends often last a lot longer than expected.  That's why I'm pretty non-directional, and rely on the anchor trade strategy to smooth my equity curve rather than market timing. 

 

 

I know we have a lot of strictly non-directional traders here... just wondering if anyone is exploring the idea of a medium-term downside bias in 2014. I usually don't have any conviction about market direction one way or the other, but lately I've seen some data points suggesting that we're at or near a market top.

 

It started with a video I saw a few weeks ago on tasty trade. The segment took a look at the 5 secular (long-term) bull markets since the 30's (including the one we're in). So far, all of these markets ran for 54-59 months and ended in a sharp decline of 28-54%. The current bull market started in March'09 and is 57 months old. Click here to see the video.

 

Another indicator that I like to keep an eye on is the Value Line Median Appreciation Potential (VLMAP). VL takes their standard universe of ~1700 stocks and estimates 4-year appreciation potential for each one. The MEDIAN figure is currently 30%, or ~7% per annum. This number has historically been a pretty good indication of market bottoms and tops. To my knowledge, 30 is the lowest figure seen in many years. I believe the lowest it's EVER been is 25. I'd say 80 is a "normal" figure, while market bottoms can see numbers in the 150-200 range (March'09 was 185). If the market goes even 5% higher this figure will be in unprecedented territory. There are successful trading services that use 50/100 as trading signal thresholds for VLMAP.

 

Another data point that would seem to support a sharp correction was mentioned in the tasty trade video. It's "net free credit" - i.e. total margin debt less the cash available in cash and margin accounts to cover margin calls. As of November this figure was at NEGATIVE $130 billion. This means once a correction starts it will likely be exacerbated by margin covering for a while. It's not perfectly clear whether the margin is being used mostly for bullish bets, but with the index put/call ratio at 0.64 (as of Tuesday) and the direction of the market recently, it seems there's a lot of bullish betting going on. I'll attach a spreadsheet showing the calc.  net_free_credit.xlsx

 

I'm curious to get other thoughts on this. At a minimum it seems fairly evident that we should not expect the whole of 2014 to be like 2013 was... volatility could be higher, and there could be some sharp moves.

[Mikael 31]

this earning season might shed some light. if it's really bad there might be a pull back, but then again the fed can always flood more cheap money to prop it up, so who knows. 

[QZW 6]

I was up 17.8% on my entire fund in 2013 and am out of equities as of Jan 1; will wait to establish positions near-term when the market corrects. I typically play with indexes (SPY, QQQ) for speculation, but in 2013 I made money on long CF, MA, UNP, V, LO and short AAPL. I usually stay 80% in cash and long puts every weekend,-very conservative. We will start Anchor-like strategy and now roll around large numbers of low-delta SPY weekly puts for income. Non-directional strategies like SCO are the best bet for 2014, in my view. Predicting markets long-term is not useful, but technical analysis is. Good luck to all in 2014.

QZW

Edited January 5, 2014 by QZW

[Fatiflyer 3]

The guys at tastytrade are expecting an increase in IV for a long while, they remind me to a known children's story Петя и волк, I respect their opinions quite much for their experience and do agree that it will happen when no one will expect it, that was my reason to stick to anchor trades.

 

It has been a tough time for those option delta neutral traders defending their calls, personally I've learned a lot of this market situation, now when my setups are skewed to make them more comfortable to the rising markets is time to the market to change (this is my own foolish reason to be after a huge pullback )

 

Regards