Tuesday, July 31, 2007

Fear Spikes On Today's Market Decline

The news today that mortage lender AHM could not meet its margin calls and may have to liquidate weighed heavily on the financial markets.

The early strength we saw this morning quickly subsided, and the markets staged large reversals. This news may not have had the same magnitude when the markets were at their highs, but when the market is in a correction, this type of news always spooks investors.

But is important to remember that we have seen a 6-8% selloff in each of the last 4 years. Currently, the S&P 500 is down -6% from its highs. In each of those prior selloffs, the market went on to recover and make new highs. I don't think this time will be any different.

In each of those selloffs, the fear indicators we follow showed dramatic spikes higher. From a contrarian perspective, this is good as it helps the market bottom. Today, we saw many of these indicators spike again. To wit:
  • The volatility indexes spiked +13%, above March levels
  • The ARMS Index surged to 2.50
  • The CBOE put/call ratio hit 1.26, a very high level
  • The ISEE fell to 105

The S&P 500 is also extremely oversold, though it remains above its long-term 200-day moving average. So while it is difficult to pinpoint exact bottoms, my game plan has not changed as a result of today.

I still think it is likely that the market will bounce from these oversold levels. After a bounce, it will likely have some sort of retest of the lows, and from there a more solid bottom will be in place and the market will go on to make new highs. Valuations are still very reasonable, the job market is strong, and the global economy is solid.

There is no reward without risk. But we should all be used to it by now. The wall of worry we continually talk about is still firmly in place.


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