Trader Talk

Four things to watch for a market bottom

Key Points
  • Margin debt has reached record levels lately.
  • A historic ocean of money flowed into exchange traded funds in January.
  • If the credit markets don't show stress, then it's more likely that this is a buyable dip.
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Four things I will be watching in the next couple days that could signal the selling is finally over:

1) Margin calls: A demand by the brokers for traders to deposit additional money in their accounts. Margin debt was at a record level recently — people have borrowed a lot of money to trade. In extreme situations, your firm can force the sale of securities in your accounts to meet a margin call, and your firm can increase the maintenance requirements if the markets drop dramatically — essentially saying you have to put up even more money.

2) The behavior of fringe products like volatility securities and leveraged and inverse exchange-traded notes: There has been widespread commentary about the behavior of Volatility ETNs like the VelocityShares Daily Inverse ETN (XIV), which is a product that allows you to bet volatility is going down ... but when volatility goes up, you lose money, the inverse of how much volatility goes up. With the Cboe volatility index up 115 percent Monday, that may be an issue for investors.

3) Fund flows: Remember, a historic ocean of money came into exchange-traded funds in January — north of $55 billion into stocks, according to Much of that was retail investors eagerly putting money to work on the back of strong earnings and an expanding global economy. There have been outflows from U.S. equity funds since the beginning of February, about $12.5 billion, according to KBW. Financial ETFs, however, have seen inflows recently as rates have risen. The big issue: How will retail investors react, particularly those who bought aggressively in the beginning of the year? The volume weighted average price (VWAP) — the average price for the S&P 500 this year — is now roughly 2,770 on the S&P 500. We are more than 120 points below that. That means that on average anyone who bought this year is under water by nearly 5 percent.

4) Finally, watch credit: If the credit markets don't show stress, then it's more likely that this is a buyable dip, rather than the end of the bull market. If stress spreads to credit, investors will be much more concerned.

The good news is the market is getting cheaper. We've gone from really overbought to oversold in a little more than a week. A week ago, the forward price-earnings multiple for the was a pricey 18.5 well above the historic normal of 15 to 16. At the open Monday it was down to 17.9, at the open Tuesday it looks as close to 17.3, not dirt cheap, but a lot cheaper than a week ago.