Today’s 300+ point drop in the Dow should come as a surprise only that it took 9 trading days to happen during which time the index was stuck in no-man’s land between the 50 & 200 DMA trend line.
After 3 failed tries to reach the 50 DMA, the Dow gave up the ghost and followed the trajectory of least resistance – down.
Today’s drop was attributed to the Obama election but it could have very well happened had Romney won because of the lack of the ultimate underpinning of a bullish market – weak cash inflow into it.
This problem can be seen on the chart by matching the little blue circles on the price at the top with the circles on the bottom representing lower momentum – meaning that each attempt at the break in Dow was accompanied with less conviction.
In fact, it is rather remarkable that the Dow even mingled sideways for 8 days, thanks to so much strength in the financials.
Today, however, these financial have given up their strength and this is a very strong signal that we maybe entering the last leg of this mini-correction.
The retracement lines above show that we are right at the 50% correction but with so much fear in the market it is reasonable to expect another leg down towards 12,600 just enough to get many to finally believe that the old trend is over, that stocks need another trend line and that such trend line will emerge after all of the margin debt gets cleaned out of the books.
Back in October we talked about the necessity for margin debt to get cleaned out and how such process whacks the index below the major 200 DMA trend line.
Margin debt data, however, is notoriously late and as such very useless in forecasting such trend breaking moments like the one today.
Still, though, margin debt has been on a powerful upswing in September and the bullish run in equities, in all likelihood, cranked up that debt even higher beyond the $315 billion recorded at the end of September. Anecdotally, lot of stories circulated last several days as to how folks were levering up on bullish bank calls because, presumably, they had no cash to lever up via margin hence no surprise that financials are leading downward.
When such account net indebtedness rises it becomes impossible to raise more cash to lever up on any additional trades and this absence of new cash stops fueling the index higher making such debt expensive to maintain.
The fact that we traded sideways for 9 days instead of, say, 3 makes this particular sell-off nastier because it is 6 days of additional unbearable positions that need some trimming out of the account.
The margin debt graph above shows that the absolute debt typically peaks just before the sell-offs (shaded periods) so if we are selling-off now in November, the margin debt had to have peaked in October (data yet to be supplied).
Fundamentally, of course, nothing has changed today except that certain stocks are going on sale and that should present itself as a good time to add some positions particularly among the financials.
More problematic is the longer-term view which, as seen on the weekly chart shows up as weakening momentum and a slack relative strength measure… discussion for other time.