The “bombshell du jour” over the weekend was FBI Director James Comey’s announcement on Sunday afternoon that he found no reason to prosecute Mrs. Clinton over her e-mails just one week after reopening the investigation. The initial market reaction, based on the contract prices in the overnight and early Monday morning’s futures market, was one of elation as stock index futures and international markets rallied. 

But what happens on Sunday night and perhaps on Monday may or may not have a lasting influence on the election or what happens Tuesday. As a result, we suggest caution. To quote Yogi Berra, “it ain’t over ‘til it’s over.” In other words, no matter what happens on Monday and Tuesday, the real action is likely to be on Wednesday after the actual election results are known and the potential shouting matches, legal threats, and even possibly social unrest begins.

Before the Comey surprise U.S. stocks had fallen for nine straight days as of the close of trading on November 4^th, for the first time since 1980. This painfully slow decline led to a rise in fear not seen in investing circles since the start of this year. As a result, the most contrarian viewpoint at this moment in history was that the stock market was poised to rally. And that’s precisely what the charts were saying was plausible, although if and when such a rally would or could materialize was highly uncertain, until Comey struck.

In fact, the rally in stock index futures after the Comey announcement on Sunday is proof that the market can and will rally in response to news that it considers to be positive. But what happened on Sunday night may not be what happens on late Tuesday night and early Wednesday morning. What we know is that this highly oversold market, even if it rallies further beyond Wednesday, will still have to deal with the aftermath of the election, the Fed’s next move, and the old adage that an oversold market can become even more oversold. 

Getting Sentimental

The gloom and doom was so thick that you could almost cut it. I’ve been very bearish for some time and I remain cautious, but the charts and the overwhelming negativity can’t be ignored. So even if there is a complete washout of prices after the election, it would not be surprising that such an event could become a historic intermediate term buying opportunity. Consider the following measures of market sentiment: 

1) The CBOE Put/Call ratio on Friday, November 4^th, was 1.37 (the ratio is derived by dividing the number of put options traded into the number of call options). High numbers, such as Friday’s, are often a sign that investors are too bearish and a market bottom may be close. Even more remarkable; the ratio’s end-of-the-day reading has averaged 1.13 for the past ten trading days. Under normal circumstances any single-day ratio above 0.9 is considered at least short-term bullish.

2) The latest poll from the American Association of Individual Investors shows that only 23.6% of the association’s members are bullish while 34.3% are bearish. This level of bullishness is considered very low, which is viewed by contrarian investors as a positive omen for stocks.

3) The CNN Greed and Fear Index is at near-panic levels with a reading of 14, falling from a level of 49 (neutral) just a month ago and 72 (greed) a year ago. Fear readings are often bullish signals while greed readings often signal a major market top.

4) The CBOE Volatility Index (VIX) closed the week at 22.5, a relatively high reading that not seen since the major market bottom of February 2016 which was preceded by two readings over 30. The highest reading ever on the VIX was above 80, which coincided with the bottom that marked the current multi-year bull market.

The Drooping Charts

It’s rare to see price charts that show a falling market day after day without one or two up days in between. Yet, this is what we’ve seen for the past two weeks. And even though the percentage decline in the S&P 500 (SPX) since the August 26^th top is less than 5%, the last ten trading days look, as they would say in certain parts, just “plum awful,” or closer to home, “droopy.”  Indeed, no matter how you describe the price action, the message is clear: there have been few buyers in this market for the past three months.

Figure 1 – The S&P 500 Index (SPX)

The S&P 500 Index (SPX) is now on the cusp of falling below its 200-day moving average (red solid line), which divides bull markets from bear markets. A sustained break below this key price area would likely lead to accelerated selling in the short term and perhaps longer. The overwhelming presence of sellers is further illustrated by the On Balance Volume Indicator (OBV, top panel), which topped out in August and has been heading down ever since. This selling pressure has been worse over the last ten days and is confirmed by the volume bars (pink bars, main chart panel). As a result, pink has become the dominant color scheme on the price chart of late.

On the positive side, prices have fallen well outside of the lower Bollinger Band (lower green line) which suggests that some sort of bounce is likely before too long. Also, a potential positive is the action in the Standard Deviation indicator (STDDEV, lowermost panel) which is rising, indicating that the potential for increasing volatility, and possibly a change in the trend is approaching. Note a similar pattern in STDDEV in late June, around the Brexit period.

The Inside Job

Inside the market, things are bit more nuanced. The NYSE Advance Decline line (NYAD, upper panel) looks positively awful. This indicator topped out in mid-September and, as it has with near perfect accuracy over the years, has predicted a significant decline in the market by topping out. 

Figure 2 – The NYSE Advance Decline Line compared to three major indexes

This much is true: You can argue that the S&P 500 has only dropped 5% in the last three months, which is a fairly benign number. But the action in the AD line suggests that the level of selling in individual stocks has been much more significant than what we see in SPX. Another way to look at it is that we’ve already had a meaningful “stealth” correction where the average stock has been hammered while SPX has dropped in a gentler fashion. This is an important point which is illustrated further in the next section.

Sectors and the Election

Now, I want to focus on the indexes, in the three bottom panels of the AD line because they tell an interesting story. SPX is the top panel and it’s showing a very definite downtrend. BKX, the financial services index, has been moving higher over the same period. I’ve noted before that this suggests Wall Street is banking on a Hillary Clinton win in the presidential election, and a continuation of favorable policies toward Wall Street. NBI, the Nasdaq Biotech Index, has a much better correlation to the NYSE Advance Decline line, as the index has lost over 16% of its value since topping out in mid September. Also note that as the polls have gotten tighter, the banking stock rally has slowed. And on Friday, we saw the first real bounce in biotech.

Brexit Repeat?

The election seems to be the key event for investors at the moment. And just as the market found a bottom after the Brexit vote, it is possible that history could repeat itself on this side of the pond. Clearly, a major post-election market bottom and a meaningful rally are not guaranteed. But from a purely technical standpoint, based on contrarian analysis of the market’s sentiment and a thorough review of the price charts and corresponding indicators, it is a viable potential outcome.

For sector investors, it’s a good idea to keep an eye on banking and biotech, especially on Monday as the action in those two sectors could provide useful clues as to what the smart money may know, or thinks it knows on the election’s eve. Only one thing appears certain; something is going to give in the next few days. The market is clearly poised for a big move, and the overwhelming negative sentiment sets it up for a positive surprise. On the other hand, maybe we are in the very early stages of a major meltdown, since falling markets can always fall further. No matter what, it’s a good time to pay very close attention to one’s portfolios and to have a plan of action in place for any possibility.