October 19, 2014

Is JP Morgan Giving the Green Light to the Bulls?

From a recent JP Morgan note:
The recent correction is also raising questions about which indicators have been useful in gauging equity market bottoms. The current equity market correction is the 19th (with 5% or more decline in the S&P500 index) since the current equity bull market started in March 2009. One simple way to assess which indicators have been useful in calling the bottom is shown in Table 2. Table 2 shows the minimum reading of four technical indicators within 2 days before or after each equity market bottom. These four indicators are 1) 14-day- RSI or Relative Strength Index which is a price based technical indicator comparing the magnitude of recent price gains and losses to identify overbought or oversold conditions, 2) 14-day VZO or Volume Zone Oscillator which is a volume based technical indicator. VZO separates up volumes from down volumes, it smoothes these volumes by an Exponential Moving Average for a given period, and then divides by the total volume for the same period. Similar to RSI, VZO’s usefulness is in identifying overbought/oversold volume conditions, 3) the S&P500 skew which is an option based price indicator we regularly use in our Option Skew Monitor in Chart A8 in the Appendix and the 4) call/put turnover ratio for US equities as reported by CBOE which is an option based volume indicator.

The green colour denotes a “successful” indicator, i.e. an indicator which happens to be below its lower threshold within 2 days before or after the market bottom. The lower threshold is defined as two standard deviations below the mean since 2009, for all of the four indicators. The message from Table 2 is that RSI and VZO appear to be the most useful indicators followed by the call/put turnover ratio. All these three indicators are currently pointing to oversold conditions. Last time this happened was in August 2011. One of the characteristics of the August 2011 correction was that the equity market was slow to recover.