Signs of a Classic Capitulation

Last week’s sell-off had all the signs of a classic capitulation. The TRIN/ARMS index of the NYSE spiked
to +3.4, which is evidence of a high volume sell-off (Thursday was a 97% down volume session). What
happens after such a high volume wash-out?

In most cases, these capitulation sessions are quite near to important tactical bottoms but if we go a bit deeper into
the details we can see a big difference between whether these sell offs occur in an uptrend or if the market is
trading in a downtrend. In 2009, we had 7 sessions with a TRIN/ARMS index spike above +3.0, which is a threshold
we can view as a contrarian buying trigger. 5 out of 7 selloffs were more or less classic wash-out sessions in an
uptrend and ex-post great buying opportunities. After 1 or 2 stabilization sessions the market reversed and continued
to rally. However, the other 2 capitulation sessions occurred in downtrends, in late February, where the
market was in the final stages of its Q1 collapse and in early July in the late stages of the June/July correction. In
both cases the market needed another 5 sessions before the final low/reversal took place and the market started a new
bull leg. In both cases further downside was quite limited and the down momentum started deteriorating, which is
another classic attribute of a tactical trading bottom.

Conclusion: It’s fact that last week’s bounce was shorter than favored but the new lows are still fully inline with our
Q1 correction scenario and our late February low projection. Last week we said that we wouldn’t be too
aggressive in playing a bounce as the market should be vulnerable for more downside. We stick to this call and
would concentrate more on picking the next major low instead of playing bounces. With a rising CBOE put/call
ratio and the biggest spike in SPYDER volume since the March lows, last week’s sell-off already had a lot of a final
capitulation, so that another bounce attempt this week is likely. However, following our cyclical roadmap we still
favor a 4-month cycle low in late February, so over the next 2 to 3 weeks we see equities still vulnerable for more
down tests. With last week’s capitulation and the pattern in the NYSE TRIN index, we think we have seen 90% of the
downside, so the next 2 to 3 weeks could be more of a bottoming process, as to expect more of last week’s
aggressive bear attacks. From a price perspective we stick to our recent call and see most markets pulling back to
their 200-day moving averages. Our SPX target is unchanged at 1040 to 1020 and the Nasdaq Composite
should see a low at around 2050. Given last week’s capitulation we are changing our tactical bias and
recommend start buying/ accumulating aggressively into further weakness to position for a significant rally in
equities into March/April.
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