There may have been more to the selloff earlier in February than just over-leveraged players caught on the wrong side of volatility.
In his "Off the Charts" segment on Tuesday's episode of Mad Money, Jim Cramer checked in with Carley Garner, the co-founder of DeCarley Trading, the author of "Higher Probability Commodity Trading."
Garner told Cramer that more people are to blame than just foolish speculators. She argues that the market was already broken in early January, and the bulls were victims of their own complacency and irrational exuberance.
She started with a chart of the E-Mini S&P 500 futures, which trade 23 hours a day. The benchmark traveled from the 2,400s in September to the 2,800s at its peak last month -- practically in a straight line, without any sort of back and fill trading. In Garner's opinion, the S&P was just as broken as it climbed relentlessly to new highs in January as it was near the February lows.
Garner argues that asset prices aren't supposed to move straight up or straight down unless you have a sudden and dramatic change in the fundamentals. Even with tax reform, the move to 2,800 was extreme.
When trader emotions take over, they tend to throw reason and even sanity out the window. As far as Garner's concerned, that's why the market both soared higher for most of January, fueled by collective euphoria, and then folded like a wet paper bag as euphoria gave way to panic.
She notes that the S&P is almost right back to where it was at the end of 2017 -- up about 3% -- and she says you could make a decent case that the S&P never should've traded above 2,730 in January.
When the S&P started pushing up against that ceiling of resistance at the beginning of the year, the Relative Strength Index or RSI, a key momentum indicator, hit 80. That's an extremely overbought reading, indicating stocks had risen too far, too fast. But the S&P easily broke out above 2,730 and a few weeks later, the RSI surged to 90 before stocks peaked.
In Garner's view, these readings were classic signs of a broken market, yet people who were making money in stocks didn't want to admit that anything was wrong.
After the S&P peaked on Jan. 26 at 2,872, it plunged to 2,530 in less than two weeks. Garner says that this move made perfect sense from a technical perspective. The S&P tumbled down to the floor of support at its long-term trend line and that's where it bottomed.
At this point, Garner thinks we're back where we should be, with the S&P in the 2,700s and the Relative Strength Index having settled back into neutral territory.
For another perspective, Cramer and Garner looked at the longer-term weekly chart of the S&P 500. Before the big run-up in January, the S&P had been trading within a well-defined uptrend since early 2016.
Since then, each rally had stalled out when stocks became overbought at the high end of the channel. You'd then get a pullback and afterwards the S&P would resume its march higher.
January was different. Suddenly, the S&P pushed through the high-end of the channel. In Garner's view this was all about FOMO -- fear of missing out -- and the MOASS -- the mother of all short squeezes. New money piled into the market, the short-sellers got crushed and many were forced to cover, or buy back stock to close out their positions. When gravity finally reasserted itself, the S&P didn't break down to ridiculously low levels -- it didn't even test the low end of the uptrend channel. But because it was falling from rarefied heights, the collapse felt almost apocalyptic.
If not for the huge run in the first three weeks of January, Garner doubts anyone would've been talking about a broken market when the inevitable selloff came. In the long run, she thinks the market worked exactly as it's supposed to: it forced out the obstinate bears, then washed out the euphoric bulls, and now it's back to a healthy equilibrium.
Garner and Cramer also looked at a chart of the VIX going back 30 years. The market generally works its way higher long-term, so most of the time you can make steady money shorting the VIX, which is why so many hedge funds were doing it. Garner says this is a really dumb short: you have limited reward versus massive risk.
More important, for her, these VIX traders are the symptom, not the disease. The actual ailment is euphoria, which is why so many funds were foolish enough to make such a risky bet in the first place.
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