Market action today was encouraging and supportive of our case that last Friday marked at least a short-term low for equities. An early plunge of nearly 400 points on the Dow this morning gave way to an upward move of nearly 800 points. Market internals were positive as well, as advancing stocks exceeding declining stocks by four to one, and upside volume exceeding downside volume by four to one. In addition, the VIX (an index measuring the degree of fear in the market) hit an all-time high today, suggesting extreme pessimism.
One of the most accepted notions in the financial markets is that important lows eventually must be “retested” in order for market participants to have confidence that a market bottom will hold. Most market bottoms are retested over a period of weeks or months; however, in this case it appears we have seen a retest in just four days. Viewed in this context, the downside action following Monday’s historic gain was necessary and healthy, assuming Friday’s low was not violated.
Only time will tell if the markets have put in a bottom. However, today’s action has the potential to shift psychology to the positive, if only for the short term. The critical market factors to watch for continued improvement remain firmly focused on the credit markets: that is, the LIBOR rate and credit spreads.
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