The BOE rescues the markets

Posted by Cam Hui -

Mid-week market update: Before going to bed last night, I check the overnight market and saw that S&P 500 futures were down as much as -1% and thought, “Here we go again!” I woke to see that the BOE had committed to buying Gilts “on whatever scale is necessary” which sparked a risk-on stampede.

The market was ready to be rescued, it just needed the bullish catalyst. One of the signs of an oversold stock market is the VIX Index rising above its upper Bollinger Band, and the VIX had gone on an upper BB ride for nearly a week. Tactically, the bullish impulse has historically petered out when the VIX reaches its 20 dma.

Ready to rally

The market was washed out and it was ready to rally. All four of my bottom spotting indicators had flashed buy singals in the past week.

  • The VIX above its upper BB, indicating an oversold market;
  • An inverted VIX structure, indicating fear;
  • The NYSE McClellan Oscillator was wildly oversold; and
  • TRIN spiked above 2, indicating panic-driven selling.

For some context on how badly price momentum got wiped out in the last downdraft, the % of S&P 500 stocks above their 200 dma fell to 10%, which is rare and has occurred four times in the last 20 years and marked major bear markets.

As well, the VIX Index had reached the bottom of its target zone yesterday, which was a sufficient condition for a short-term bottom.

When markets panic like this, it’s difficult to trade the bottom as markets can be volatile and extremely headline sensitive. Trading guru Brett Steenbarger recently discussed wildly oversold stock markets and came to the following conclusion:

Positive average returns don’t mitigate the need for sound risk management.  If central banks need to see significantly weaker economies to crush inflation, then stock markets can be expected to anticipate that weakness.  The average individual investor is long stocks and long bonds.  Both positions are getting crushed and could see real disaster if central banks need to continue to administer harsh medicine.

In all likelihood, the BOE decision was the catalyst for a relief rally. As well, CNBC reported that San Francisco Fed President Mary Daly struck a less hawkish tone in a speech today. My inner trader is long the market and he will exit his position once the VIX reaches its 20 dma, but as Steenbarger pointed out, sound risk management is a key to trading these volatile markets.

Disclosure: Long SPXL