Have We Seen the Market Bottom?

The last two weeks have seen material volatility as we had a serious market decline and substantial rebound in stocks. Much of the blame has been pointed toward China, but there is no denying the material declines in all global markets. The VIXC, which is the Canadian measure of implied volatility on the Canadian markets spiked intraday to 38.14, which is the highest reading since the market crash in August and October of 2011.

Back in both 2010 and 2011, these types of spikes in the VIXC marked the capitulation phase of the market decline and lead to intermediate bottoms in the markets which proved to be great buying opportunities for investors.

So the question on all investors minds – is this a buying opportunity again?

While I always heed to the more cautious side of the outlook, I remain initially sceptical. There are a number of precipitating factors that differentiate this situation from 2010 and 2011. In both the cases of the 2010 crisis in Europe and the 2011 U.S. Debt Ceiling crisis, the problems were abroad and Canadian stocks were simply caught in the tide of global uncertainty. 2015 is shaping up to be a far different situation. The Canadian markets are overshadowed by a plunge in commodity prices driven by a global slowing of growth. This is overshadowed by broad deflationary pressures.

The scenario has now made the announcement off a technical recession almost a certainty, leaving many question marks as to if the heavily indebted Canadian consumer can withstand the fallout. The key question that needs to be answered, which has yet to reveal itself lies in concluding if the:

Canadian stock market is simply in the midst of a correction or is it in the midst of a bear market!

This is why rushing to buy this dip can prove to be a bear trap.

In a number of our prior blogs, we have advocated the purchase of protective puts to reduce a portfolio’s volatility. That was in a period where the options were relatively cheap. Today, the material rise in the VIXC is reflecting the new expectations for increased volatility, making the puts far more expensive at a time when the market has already considerably dropped from its year highs.

For those that remain pessimistic over the short-term, the collar strategy represents a volatility neutral strategy where the increased covered call premiums are helping finance the more expensive put premiums. Overall, there is a diminishing payoff in further hedging, but may still have merits, particularly if investors need the psychological reassurance on limiting risk.