Friday, October 4, 2013

Bad news and the October outlook

In recent commentaries we’ve discussed the likelihood of a broad market correction due to a series of divergences among the major averages.  The divergence between the Dow and the NASDAQ, for instance, suggests insider distribution.  Not surprisingly, insider transactions show that corporate insiders have done more selling of their company’s stock than at any time in several months. 

Uncertainty in Washington has also weighed heavily on stocks as investors ponder what effect a continued U.S. government shutdown could have on the economy.  Broad market volatility continued to expand as the Volatility Index (VIX) is up 20% this week after closing at a new 3-month high (below).  As long as VIX is in this position the stock market will be quite vulnerable to negative news headlines.

Speaking of headlines, in the weeks leading up to the market pullback the news headlines c magazine covers were anything but negative.  Optimism bordering on euphoria was reflected on the front covers of several major financial magazines, including Barron’s, Time and Businessweek

The Sept. 23 issue of Time magazine, for instance, featured another one of those infamous bull market covers.  The bull was displayed rather prominently on the cover under the headline, “How Wall Street Won.”  Paul Macrae Montgomery, a pioneer of the magazine cover indicator, told Barron’s last month that the Time cover suggested “an 80% chance the market will top in a month and will be lower a year from now.” 

The following week Time featured a story with the headline, “Can Google Solve Death?” on its front cover.  Google represents one of America’s biggest corporate monoliths, and an article suggesting that even death itself could be conquered by the juggernaut is indicative of excess optimism which is normally seen at market tops.  The cover graphic on a recent issue of The Week suggests complacency about the outsized role of Wall Street in the U.S. economy and was also suggestive of a top.

The combined picture presented by these covers is one of investor exuberance – a potentially dangerous state of mind entering a month that historically has seen more than its fair share of volatility.  Until we see a return of healthy levels of fear in the headlines and sentiment indicators, investors might consider scaling back on purchases and watching key support levels for potential breaks in October.