Why the worst may not be over for stocks

Things haven't gotten bad enough to get good again.

That's the paradoxical zone in which stocks find themselves, according to some market-watchers. Despite a dramatic (and deep) decline to start off 2016, an absence of the type of panicky selling that so frequently marks a bottom may suggest that the worst is not over for equities.

"There are three reliable signs of a market bottom, where things get so bad it is safe to step in," Convergex chief market strategist Nicholas Colas wrote Friday.

"First, when the S&P 500 drops 5 percent or more in one day. Second, when the CBOE VIX Index tops 40. And third, when everything sells off for a few days and correlations for all equities approaches one," Colas added. "None of these events have yet occurred. And so we wait…"

The VIX, which is calculated from the prices of options on the S&P 500, is a widely watched by traders, since it gives an indication of how much nervousness is in the market.

Interestingly, while this index has certainly risen over the past three months, it has not reached levels that would suggest investors are buying "insurance" (in the form of bearish put options) at any price. The VIX has barely crossed above 30, while it rose above 40 in August, and reached nearly 90 in 2008.

Longtime VIX trader Brian Stutland said last week on CNBC's "Futures Now" that he's looking for the VIX to display "this sheer sense of panic, where people are just grasping for insurance to protect themselves. That's what I want to see in the market before I become a buyer."

On the other hand, some say the selling is just about over.
Cannaccord's Tony Dwyer, who wrote in a recent note that "the bottoming process is frightening and takes time," said recently that "yes, sentiment is bad enough, and perception of fundamentals is bad enough" to make stocks look attractive.
"The mistake we make is trying to call the absolute bottom" — a task Dwyer has come to view as a fool's errand, as well as a some irrelevant question.

Whether or not stocks are set to break below the two-year lows set Thursday, "if you're looking six to nine months out, I think it gets better from here," he told CNBC in a phone interview.

Indeed, sentiment does appear to have deteriorated substantially. In a Friday note, the Bank of America Merrill Lynch equity strategy team led by Savita Subramanian showed that Wall Street sell-side analysis has become markedly bearish, forming a contrarian "buy" signal.

"It has been a bullish signal when Wall Street strategists were extremely bearish… When our indicator has been this low or lower, total returns over the subsequent 12 months have been positive 95 percent of the time, with median 12-month returns of +24 percent," the team wrote.

It is high irony, then, that this mention of sentiment came buried in a bit of sell-side Wall Street strategy research, in which BofAML cut its S&P 500 target from 2200 to 2000.

CNBC

Read more:

• US – Iran – Iraq tension remain the main driver of the stock market today
• How top market players on Wall St think 2020 will look like on financial markets
• Money Flow before the start of the new trading week
• Cincinnati Financial Corporation (CINF.US) -Opportunity for long positions
• Asia stocks gain as Fed signals no rate cuts in 2020