What to Expect From This Bounce?

When dealing with market conditions like the ones we are faced with now experience plays an important role.  Many individual investors have forgotten what it feels like to experience declines of the magnitude and the severity that we have seen at the onset of 2016.  Oh sure, there were some declines last year too, but the declines this year carried with them additional concern because it seemed like selling pressure hit almost like clockwork as the new year began.

Unlike the declines of last year, individual investors actually appear to be a little scared, quite possibly for the first time in years, but they are not the only ones.

Institutional investors are also no longer sanguine.  Institutional investors certainly look at markets in different ways, and they look for opportunities during markets that have been beaten up, but they also look to sell on relative strength when the times are appropriate to do so, and that leads me to an important point.

Rarely do markets move straight up or straight down, but at the beginning of 2016 we have seen almost unabated selling pressure hit this market and cause it to move straight down from the onset.  This is very rare, it does not happen all the time, and we can rationalize it by talking about valuation levels or the extension of margin debt by institutional investors, or something else, but instead of doing that we should just accept it for what it is and recognize that the market has fallen hard in a straight down fashion and that's unusual.

When that type of thing happens there is almost always pent up interest in selling the market on relative strength.  This is just normal, nothing else, because some investors rationalize that they should be selling the market on relative strength after declines of the magnitude that we have seen recently.

To some investors the converse of a straight down market move would be a straight up market move, and in large part that's exactly what happened last year when the market got hammered, but expecting that to happen again this year might very well be foolhardy.  The dynamics that were at play last year that kept institutional investors interested in adding margin debt and supporting asset prices no longer are at play.

Instead, most of those institutional investors have more of an interest in reducing margin debt exposure, as we have discussed, and that is yet another reason to expect selling pressure from time to time on the heels of strength.

This observation does not suggest that the market is going to continue to plummet as aggressively as it has recently without first experiencing more of a sustained up move.  Instead, what it suggests is that we should not expect that up move to be one sided.  There should be backing and filling, the market should experience undulations that at some points cause concern, and the market should back and fill its way higher after finding a bottom, and it should not move in a one sided direction.

If it prudently backs and fills its way to higher levels that will add stability, but if the market instead increases aggressively from recent lows and experiences a once I did move higher, not unlike the one sided move lower that has taken the market down to these levels, it will simply run the risk of falling sharply and aggressively again in a manner that will likely shake the street once more.