Friday's Plunge May Have Been Manufactured... And A Bottom

The climax, of course, was Friday. More puts traded hands on Friday than any other day we'd seen since early 2016. [The call volume is plotted with green bars, and the put volume is plotted with red bars.].

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Early 2016, by the way, marked a rather major bottom and the beginning of a pronged rally. It's possible we've once again cleaned the slate by flushing the last of the sellers out.

That's not all.

Friday was also a huge day for index funds. Inexplicably, they choose to rebalance their portfolios on the third Friday of the final month of the quarter as well, exacerbating the volatility. Given that a record number of capital is now tied up in index-based funds, it comes as no surprise that this month's rebalancing alone is expected to have driven almost $24 billion worth of trading activity.

The day's stock-trading volume makes clear that at big swath of this rebalancing activity was part of Friday's action. It was the highest volume day we've seen from the market since August 21st, when stocks were crashing in response to turmoil in President Trump's White House.

(Click on image to enlarge)

That plunge didn't last either. Indeed, most volume spikes over the course of the past several months resulted in big-time pivots, both up and down. In light of the unusual circumstances behind Friday's painfully ugly volume surge, it would be unwise to assume the current downtrend is destined to continue. Market constructs like expiration days and index fund rebalancing may have created the very capitulation we've been waiting on.

Clearly this isn't an environment where such a theory should be blindly tested. The severity of the current pullback has become so painful that terrified investors may have concluded the only possible outcome from here is more losses. If they believe it enough, they'll eventually make it happen... a self-fulfilling prophecy.

Take a closer look at the bigger picture though, and you'll see the only thing there really is to fear here is fear itself.

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Mark Borkowski 1 year ago Contributor's comment

Under any other down cycle or circumstances, I would have agreed with J. Brumley. This market adjustment feels much different than any other I can recall in over a decade. The partial shutdown of the American government is only a head fake that should not last more than three weeks. The big issue that has been ignored is the potential trade deal with China. Now that the door has opened, this will be one of the most difficult trade negotiations in U.S. history. President Trump should take a back seat. Americans and Chinese have lost serious respect for this complex man. Official Chinese media indicate the Chinese are not in a hurry to make a new deal. In fact, they believe they are going to "improve" on current trade relations. The prolonged discussions will force the market down. Stay tuned.

Gary Anderson 1 year ago Contributor's comment

Interesting concept. But we are still led by Hoover 2. Tariff mayhem and labor earnings could hurt the market going forward. We may not be in the Roosevelt era where he was determined to underpin the market with government action. It wasn't Hoover who made the famous quote about fear that you cited.