Market Corrects As COVID-19 Cases Surge

Market, Market Corrects As COVID-19 Cases Surge 06-12-20

As I wrote previously, the break above the 200-dma had changed the complexion of the market.

“If the markets can break above the 200-dma, and maintain that level, it would suggest the bull market is back in play.

However, in our Tuesday follow up, we discussed how the market rally had gotten to an extreme. As such, we noted the need to become more defensive in the short-term. To wit:

“Regardless, the markets are bullish biased, and we must be respectful of that reality. No matter how you slice the data, the markets are back to more extreme overbought conditions on a short-term basis.

The break above the 200-dma triggered a parabolic advance in the market over the last week. The market is making a 3-standard deviation move to the upside. With indicators very overbought, short-term corrective action is likely. (Note the market was just 3-standard deviations BELOW the 50-dma in March.)”

That correction came swiftly on Thursday. The surge in COVID-19 cases in the U.S. undermined the “V-Shaped” economic recovery meme. As we noted, the market had rallied into overhead resistance, and the correction found support at the 200-dma.

Market, Market Corrects As COVID-19 Cases Surge 06-12-20

We can now update the risk/reward parameters from last week.

  • -2.9% to the 200-dma vs. +4.9% to previous high. (Positive)
  • -2.9% to the 200-dma vs. +9.1% to all-time highs. (Positive)
  • -5.6% to 50-dma vs. +4.9% to previous high. (Neutral)
  • -11.21% to consolidation lows vs +9.1% to all-time highs (Negative)
  • -15.2% to March bounce peak vs. +9.1% to all-time highs. (Negative)

The market achieved the retracement to the 200-dma support on Thursday during the most intense sell-off since March. Importantly, it was a good reminder of just how brutal markets can be when there is a complete lack of liquidity.

Correction Reduces Short-Term Excesses

Previously we discussed the more extreme levels of optimism in the markets. These indicators have historically corresponded with short-term market peaks and corrections.

The first was the large level of short-positions non-commercial speculators were carrying on the S&P 500. (These are contracts on the S&P 500 in the futures market used for hedging long market positioning.) Net-short positioning had reached a more extreme level, which historically aligns with short-term peaks and bear markets. The correction last week reduced some of that excess.

Market, Market Corrects As COVID-19 Cases Surge 06-12-20

The same goes for the total put-call ratio, This ratio measures the total of option contract buying. Investors had gotten extremely aggressive in buying call options betting the market would only go higher. At extremes, retail call option” buyers generally wind up on the wrong side of the trade. The quick rout on Thursday reduced some of those excesses.

Market, Market Corrects As COVID-19 Cases Surge 06-12-20

Note, however, the 10-day moving average of the put-call ratio remains in more bearish” territory, suggesting we may not be done with the correction just yet.

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Disclaimer: Real Investment Advice is powered by RIA Advisors, an investment advisory firm located in Houston, Texas with more than $800 million under management. As a team of certified and ...

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