The Stock Trader's Almanac

[Stock]

Volume 7, Number 3, September 2007

Season of the VIX — Market Cools Off As
Volatility Returns and Volume Spikes

By Jeffrey A. Hirsch
So much for the summer doldrums on
Wall Street this year. Stocks have
retreated as is often the case during this
seasonally weak period, but with much
more fanfare and volume than the garden
variety soft patch. Sub-prime fallout and a
global liquidity crunch have returned fear
to the financial markets, threatening the
prospects of Goldilocks’ survival.
What started out as a hot market in
July cooled rather dramatically after the
July 19 highs. Volume has soared and
volatility has returned. But before we
declare The Street in the clutches of the
bear, let’s review how bad the carnage has
really been.
As our reminder about how hot Julys
often precede selloffs was landing last
month, the market proceeded to turn tail.
At the high the Dow was up 4.4%, but
that gain was quickly erased as the Dow
tumbled 5.6% the last eight trading days
of the month, ending the month down
1.5%.
The Dow suffered the least damage of
all the major indices and is the only
benchmark that has not crossed below its
200-day moving average. This is a testament
to global growth and the earnings
boost the Dow’s multi-national components
receive from the weak dollar when
they repatriate profits.
Despite all the fear and loathing
stirred up by the current correction, the
actual damage has not been that bad. This
pullback may yet become more severe
and turn into a real bear market, but for
now support is holding right around the
200-day MAs, except perhaps for the
small caps, which may be feeling the
credit crunch more painfully.
The Russell 2000 Index of small cap
stocks fell 12.2% from its high and is
negative for the year. R2K is the lone
widely-followed index that has undercut
its March 5 low. The Dow has lost about
8% since its high. After being up 12.3%,
it is now just 3.2% higher for 2007. The
story is much the same for the S&P 500
and NASDAQ. Both are down about
9.5% from their highs and have given
back most of their gains for 2007 with
S&P off 0.8% and NASDAQ up 1.8%.
This current correction is just slightly
more severe than what transpired back in
late February and early March. A failure
to find support around the 200-day MAs
would suggest a further move to the
downside. With the Dow being the last
man standing above this critical level,
we’ll be tracking the old blue chip average
more closely than ever.
Market internals, volume and volatility
are quite a bit different than they were
back in the first quarter. We had the subprime
concerns, market weakness around
the planet, and the unraveling of the yen
carry trade back in February and March.
But now the global liquidity crunch has
gathered momentum and is threatening to
send stocks lower.
The question is whether the market
can fend off the housing slump, an economic
slowdown, inflation, and prevent
the liquidity squeeze from turning into a
run on bonds, stocks and all manner of
financial instruments. Looking at the tape
and internals the situation is less sanguine
now.

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