Tony Dwyer on When To Sell the Correction

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Yesterday, on CNBC’s Fast Money, Tony Dwyer, Chief Market Strategist & Co-Director of Research at Canaccord Genuity, said something very interesting.  He said, “Until you invert the yield curve, history has proven and proven and proven, you never ever ever ever want to sell a correction when you are not in a recession environment after an inversion of the yield curve.”

So i think this is both a fascinating and fabulous statement.  But before we discuss why this is important, we probably have to explain a few things.

Inverting the yield curve means when the short term Treasury rate is higher than the longer term.  Usually, market watchers will compare the w-year or the 3-year against the 10-year Treasury.  Normally, in a healthy market environment, the shorter term interest rate is lower than the longer.  If you think about it, that makes sense – your interest rate on a 10-year loan should be longer than your interest rate on a 2-year loan.  This is the situation today.

At times, the yield curve is inverted.  That is, the 2-year can be higher than the 10-year Treasury.  Market watchers say that if this happens, a recession is likely 6 to 18 months after.  This is because investors are moving money into the safety of short term bonds, driving up the shorter term interest rates.  The longer term rate falls because weaker economic conditions are expected, and longer term rates are expected to fall.  Notice that in the years following the 2008 crisis, the Fed lowered interest rates in response to a weakened economy and a falling stock market.

In this context, Tony Dywer’s comment makes a lot of sense.  He’s saying, if the yield curve inverts, you shouldn’t sell a correction unless you are in a recession.  So even if the yield curve inverts, things may not get worse, and you should not sell when the market is down unless there is a recession.  If there is a recession AND the yield curve inverts, then you should sell a correction, because things are expected to get worse.

I find this very interesting because the human tendency is always to want the correction to buy, but when the correction occurs, it’s very hard to actually buy because many are saying things will get worse.  So Tony is saying, you can buy the correction, because things will get better.  The exception, the time you don’t want to buy, is when the yield curve is inverted and there is a correction.  And this helps because you need something to counter all the negative press when markets fall.  You need a reason to buy the dip, and he’s providing one.  Nifty.

The Year End Trading Pattern

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As we roll into December, it makes sense to ask, is there a year-end trading pattern?  Over the last few years, trading has been similar, so I thought I’d take a deeper look.  Below, you will find the charts for the SPX (S&P Index) for 2008 – 2015.

So, for the record, I”m not a fan a a straight statistical analysis.  Studies that say “for x of y years…” don’t make sense to me, because I think you have to understand the context.  That is, the situation just before.  Even better, we should understand expectations and any unusual events, but for now, we will just look at the charts to keep the analysis consistent.

I’ve also included a table listing the seven factors I looked at and what they showed.  You can look at the charts yourself and come to your own conclusions, but here are mine:

  1. First, the situation depends greatly on where the market is coming from.  In years where there was an uptrend, December has often been a place for a pause.  That’s because if there was a significant low in recent months, there has often been a rally into Thanksgiving, which makes a pause or a pullback in December likely.  Even in 2008, when the market was in a downtrend, the market bottomed temporarily in late November and paused in December before resuming the downtrend.  Only in 2010 did the market  rally for the entire month.  In that case, November 2010 was the “pause” month.
  2. In years where the market has rallied and begun to go sideways, you can get a pullback in the early weeks in December with a short term bottom in mid-December.  The size of the pullback can vary, but if it’s within an uptrend, it hasn’t been a deep pullback.
  3. There’s often talk of the Santa Claus rally, which would be a rally between Christmas and New Year’s.  For me, the Santa Claus rally has not happened often enough to be something that you can bet on, even though CNBC seems to talk about it every year.  Several times, there have been sell offs  on the last couple days of the year that negated rallies around Christmas.
  4. There’s also talk of the January Effect (again, CNBC is likely to mention it) which is the belief that investors will buy back stocks in early January that they sold for tax losses in December.  That has happened in some years, but it’s not necessarily a high probability event.
  5. Thinking about it, you’re unlikely to get a Santa Claus rally and the January Effect.  The market would have to be really bullish for that to happen.

So given this historical data, what is the outlook for this year?  Because we’ve had a big run post Trump’s election, I do think some sideways action with some pullbacks are likely in early December.  There’s no reason to think that there would be deep pullback, at least not so far.  The Fed will most likely raise rates in mid-December (which may be another reason for pullbacks), but the market expects this.  I also think it’s unlikely that the Fed will repeat last year’s mistake of saying that there would be four rate increases in 2016.  More likely, they won’t want a repeat of the 2016 first quarter sell off, so they are likely to say that the next increase will be some time after.  In fact, they have already begun saying so.  Lastly, will the market continue to rise in January?  It very well could.  Growth seems to be recovering, the market sees Trump’s policies as bullish, and unless there is a dent in that thesis, I think it’s likely that the market will continue to rise.  So for now, bullish with pullbacks is the outlook.

Table 1: Summary of December Trading Trends, 2008 – 2015

2015 2014 2013 2012 2011 2010 2009 2008
December Description Modest Downtrend Sideways in Uptrend Pullbacks in Uptrend Pullbacks in Uptrend Pullbacks in Uptrend Pullbacks in Uptrend Sideways in Uptrend Sideways n Downtrend
Recent Market Trend Uptrend Uptrend Uptrend Uptrend Uptrend Uptrend Uptrend Downtrend
Recent Trend Low Late Sept

Early Oct

October October November October Late August July NA – Downtrend
Thanksgiving Rally Yes Yes Yes Yes Yes Sideways Sideways Yes
Early Dec Pullback 12/1 12/6 11/30 12/3 12/7 No 12/4 No
Short Term Low 12/14 – 12/19 12/16 12/14 12/5, 12/30 12/19 NA – Rally Entire Month 12/9, 12/19 12/1

Sideways

Santa Claus Rally No No Yes No No Sideways Sideways Yes
January Effect No No No Yes Yes Yes Yes No

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Let’s begin by looking at last year, 2015.

2015-year-end

With a simple look at the charts, I observe the following:

  • The market was recovering from a dip and had rallied through October
  • After the October rally, the market pulled back in early November, and bounced again into early December, so there was a Thanksgiving rally.
  • The market started to dip on December 1.
  • There was a short term bottom December 14 and December 19.
  • The market started to slide during the last 2 days of the year.  The “Santa Claus” rally, which is supposed to be from Christmas through the New Year, is debatable.
  • In January, the market sold off.  The so-called “January Effect”, when investors are supposed to buy back stocks that they sold in early December, did not happen.

We can remember that there was a rate increase in December 2015, as is likely this year.  Also, the market fell in January 2016 because the Fed said it would raise rates four times in 2016.  I suspect that the Fed will not make the same mistake this year, and will say it is some time before the next rate increase.

Next, let’s go back to 2014.

2014-year-end

Here we see the following in 2014:

  • The market rallying off a low in mid-October
  • There was a Thanksgiving rally
  • The market has a small dip on 11/30, but the short term top was 12/6/14.
  • We see a short term bottom on 12/16/14.
  • The market rallies through the 12/29/14, but falls the last two days of the year, so a bit of a Santa Claus rally.
  • The market dips in January, so the January Effect doesn’t really happen.

Already, we are beginning to see a potential pattern.

Now, let’s take a look at 2013.

2013-year-end

Looking at the same factors, we can make the following observations about 2013:

  • The market was coming off a rally in October and November 2013.
  • This includes a bit of a Thanksgiving rally.
  • The market pulled back 11/30/16 and again on 12/9/13.
  • There’s a short term bottom on 12/13/13 and 12/14/13.
  • There is a Santa Claus rally from Christmas to New Year.
  • There’s no real January effect, the market stays flat for the first couple weeks in January 2014.

Below is 2012.

2012-year-end

  • The market is rallying off a bottom in mid-November.  This is later than the rally in later years (which started in October), but still puts the market in an uptrend.
  • There is a Thanksgiving rally.
  • The market sells off just a bit on 12/3/12, but resumes its rally within days.
  • The December low is the intraday trading on 12/5/12, and there’s also a short term low on December 15, 2012.
  • There’s no Santa Claus rally, the market falls into the end of the year.  But, notice that in late December, the market starts pulling back after the 78.6% retracement (dotted line marked 78.6%) – a very common pullback level.
  • We do get a January Effect, likely because the market was falling for most of the last two weeks of December 2012.

2012 breaks the pattern of later years, but is actually a common trading pattern.  Markets, when rallying off a low, often see pullbacks when in the 61.8% and 78.6% retracement range.  The market hit this range in mid-December, so the pullbacks make sense.  In 2013, 2014 and 2015, the bottoms were in October, so December was almost two months after the low, as opposed to 2012, when December was only one month after the low.

Let’s continue with 2011.

2011-year-end

  • Market was rallying off early October low.
  • There’s a Thanksgiving rally
  • December sell off begins 12/7/11
  • Short term December low on 12/19/11
  • Sideways between Christmas and New Year, so no real Santa Claus rally
  • Market rallies in early January, so there is a January effect

Now, here’s the chart for 2010.

2010-year-end

  • Market rally rallying after a recent low in late August / early September
  • There’s not rally a Thanksgiving rally, the market goes sideways
  • Market rallies after 11/30/10
  • Market rallies the entire month, so there’s no real low in December
  • The market is sideways from Christmas through the New Year
  • The market continues to rally in January, so yes, there is a January Effect

A couple more.  Here’s 2009.

2009-year-end

  • The market was rallying of post 2008 lows.
  • A small Thanksgiving rally
  • December fall off begins 12/4
  • But the pullback only lasts for a couple days, the market has a short term bottom on 12/9/09.  There’s another short term low on 12/19/09.
  • There’s no Santa Claus rally, it’s sideways
  • The market rallies in January

The last one we’re looking at today is 2008.

2008-year-end

  • It’s not hard to remember, this was a different year.  The market was in a downtrend, but the recent low was late November.
  • There was a Thanksgiving rally
  • There was a small sell off on 12/1, but really, this was sideways
  • The month low was 12/1
  • There was a small Santa Claus rally
  • The market sold off in January, so no January Effect

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Trading News: OPEC and Trump News Ripples Through Correlated Assets

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There are days when you wake up, and you get significant moves in various assets classes.  Of course, if you’re holding positions in any of these assets, you have to scramble and figure out what’s going on.

We had two big news items today.  First, OPEC said that it had come to an agreement on cutting oil production.  Second, Steve Mnuchin was named as Treasury Secretary, and Wilbur Ross as Commerce Secretary.  Why are these two events important?  Here’s my assessment of the ripple affects:

  • Crude oil futures jump almost $4, or 8.8%, from about $49.22 as of 10:25 PST.  Whether this will hold or not is debatable, but for now the market is taking OPEC at its word, and the shorts are covering.  Not surprisingly, oil related stocks are up.  The XOP is up almost $4, or 10.4%, and the XLE is also up almost $4, or 5.5% as of late morning.  This is after significant drops yesterday (in the range of $2 – $3) on fears that OPEC would not strike a deal.
  • Bonds took a big hit.  The 10 year Treasury yield jumped to 2.377% this morning after closing at 2.3% yesterday.  Seems like a small amount, but over the last few days, yields have been falling, and this reversed the trend.  Higher oil prices are driving fears of future inflation, and this causes yields to rise and bonds to fall (inflation lowers the value of bonds).
  • Financials jumped, and especially Goldman Sachs.  Higher interest rates is good for financials.  Plus, Steve Mnuchin, Treasury Secretary Designate, spoke of policies that would support loan growth; Goldman Sachs was upgraded; and Gary Cohn, Goldman Sachs President, is rumored to be joining the Trump administration in a major position.  It seems that after nearly a decade of being a social pariah, it is good again to be associated with Goldman Sachs.  The stock is up more than $7, or more than 3.3% this morning.  The XLF is up 1.3%.  This is, again, after these stocks had a big run, and it seemed that the financial rally was ready for a pause.
  • interest rate sensitive stocks, such as utilities and dividend yielding consumer staples are taking a hit as well.  The XLU is down $1.22, or 2.5%, and the XLP is down 58 cents, or 1.1%
  • Tech and biotech, which had been favored in the low growth environment also took big hits, with the IBB down $4.45, or 1.6%, the XBI down $1.40, or 2.2%, and the NASDAQ down 44.75, or 0.92%.  APPL, FB, AMZN, GOOGL and PCLN were all down sharply in the morning, with the last three down $10 – $15.  The theory here – these stocks were the only places to go in the low growth Obama years.  Now, with better prospects for industrials, financials and oil under Trump, there’s a rotation out of tech and biotech.

It actually seemed that the post-Trump rally might take a breather, and that the post Trump rally would take a breather and pull back.  So this news is particularly disruptive to traders who were positioned for a temporary reversal of the post-election rally.  Keep in mind that short covering will often amplify a rally.

Whether these trends will hold is to be seen, but for today, the Trump rally is back with a vengeance.

Marketwatch: Into the Elections

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Looking at the charts, you can see a head and shoulders pattern in the S&P 500 index.  The “neckline” is about 2117 on the SPX cash, which we broke on Tuesday, November 1, 2016.  Once the “neckline” is broken, technicians calculate a target based on distance from the head to the neckline.  In this case, that’s 2194 (the recent top) less 2117 – 77 points.  Subtracting 77 from 2117 gives us a target of 2140.

So will the S&P reach that level?  Impossible to be sure, of course, but there are some good arguments for it.  On Friday, November 4, we touched the 200-day moving average at 2085.  With FBI Director Comey’s announcement tonight that there’s still no case for prosecuting Clinton, the futures are anticipating an up open tomorrow morning.  If Trump wins, the market will likely dive, and if Clinton wins, the market is likely to rally.

Hillary is favored, so that seems to be the more likely scenario.  If she does win, the question becomes, “what will the market do next?”  Many have proclaimed that they will sell any rally after a Clinton victory, and others have argued that the market will rally because of anticipated fiscal spending and the tendency of the market to rise after an incumbent victory.

We will have to see, of course, but i’m inclined to be cautious.  Why?  Longer term, I think the bulls are right, but in the shorter and medium term, there is cause for concern.  If Clinton wins, pressure on healthcare and on the weakened retail sector is likely to continue.  The Fed will likely raise rates in December, and earnings for Q3 were good, but expectations for Q4 and 2017 remain high, so earnings estimates may still have to come down.  Lastly, often, after a decline, the rule of thumb is not to buy the first rally because many are ready to sell the first bounce.  The real question is, will investors buy the second bounce.

Marketwatch: The Rally Continues, Market Targets 1970 range

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About a previous post, I stated that the market was targeting 1930 on the S&P.  Well, last week, as the ECB lower interest rates in Europe, the market rallied past that target.  As of tonight, Sunday night, the futures sit at around 1947.  Looking at the technicals, the markets targets 1950, which it has already hit, and then the 1970 area.

The market looks bullish, and almost ridiculously bullish.  This weekend, I was reviewing what I thought were the important forces at work:

1)  World worries seem to have faded.  Concerns about Russia invading Ukraine has fallen far off the front page.  China has done some targeted easing, allaying – at least for the moment – the fears that China’s bubble will burst.  Japan’s inflation is increasing, making it seem that Abe’s restructuring plan is working.

2) In the US, business is rebounding from an awful winter.  Many expect Q2 GDP to be 2-4% GDP growth.  That, combined with a down Q1, gives many hope that the first half of 2014 will be an average year-over-year growth of about 2%.  This makes it possible for 2014 to be a 3-4% GDP growth year.  The bulls therefore, who have called for a strong end to the year, remain steadfast in their predictions, and so do economists and Wall Street analysts.

3) Technically, Q1’s declining sectors – momentum stocks, biotech, small caps and retail – have stabilized and found, at least, a short term bottom.  Many of these stocks have even found renewed upside energy.  Also, the financials, which have been holding back, finally joined in the rally next week.

4) Lastly, the VIX, the so-called fear indicator, is at it’s lowest in years, confirming the currently stability and lack of volatility in markets.

Of course, there are many that are saying that with no worries, we should worry.  But frankly, I can’t find anything, or anything on the horizon to point at.  And so, contrary to the popular opinion at the beginning of the year that we would have a weak summer, it now looks like we will have the steady grind higher for the summer, the so-called “melt-up”.  As the traders say, don’t fight the trend.

For now, I am expecting the S&P to hit  the 1970 range, and for market breadth to expand.  Of course, we may not get there in a straight line, but I expect any pullback to be bought quickly.

Marketwatch: S&P Targets ~ 1930

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A couple weeks ago, the S&P just barely hit a new high at about 1902 and reversed.  That move actually negated the potential head and shoulders pattern that had been forming.  Because of that, the S&P targetted 1925 in the near future.

With the S&P breaking to new highs in the last few days, our new target is now 1925 – 1930 on the S&P.  We could push further, but I do think it’s likely that the market will take a pause if that number is hit.  And in fact, we could well hit that target tomorrow, it’s only 5-10 points away.

Next week could well be a hold week or pullback week given China data over the weekend and the possibility that the ECB will lower rates next Thursday.  What the reaction will be is hard to say.  Lowering rates could well cause the Euro to fall, which in turn means that the dollar will rise relative to the Euro.  Theoretically this is a negative for the US economy, but at this point, it’s a very small negative.  Interestingly enough, the effect on bonds could be good for stocks.  With the Euro expected to fall, investors may have been parking their money in US bonds.  Once rates are lowered in Europe, bond yields may actually rise as fewer buyers park their funds in US Treasuries.  Of course, these are not the only factors at play, and I will be the last to claim to know the bond market given that many more experienced people are quite confused by the recent drop in bond yields.  So we shall see.

As a general note, this market remains bullish.  The S&P is moving to new ever newer highs and the selling in high momentum stocks has paused.  Small caps are at resistance, but it will be interesting to see if they stay below resistance.  Conditions are also good for stocks.  Worries about Ukraine and China seemed to have receded from the front pages, the economic data is mixed, but no real cause for alarm.  Economists and Wall Street strategists remain bullish, and we are in the upswing, or rather “recovery”, from a very weak Q1.  In short, liquidity is not yet over and there are no clear catalysts for selling.

I have hedged positions in the S&P and the Russell.

Best Practices: Divergence Continues

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Sadly, for some reason this is another post that I thought I had published, but apparently did not.  Not sure why that is happening, but apologies to readers for the confusion in timing.  This was written May 14, 2014.

Often, the day after a big rally reveals more than the day of the rally itself.  Monday we had a big rally – and everything rallied.  Today, Tuesday, we can see what is strong, and where the cracks are.

The SPX and the DOW hit highs in the last week.  Even as momentum stocks and biotechs fell, the S&P and the DOW held up well, and dips were bought.  Often, a rule of thumb is, as markets stay at high levels, it is likely that they will continue going higher.  And so it was this week, with the SPX hitting touching 1902.17, a new high.  This is a bona fide breakout for the S&P, albeit a small one.  This denies the potential head and shoulders pattern that was setting up, and sets up a medium term target of about 1924.  Together with other smaller wings, the target range is 1910-1924.  The target off the latest swing was 1903.60, and having hit 1902.17, we may already have gotten as far as we can on that swing.  In any case, the S&P and the DOW remain strong for the time being.

Screen Shot 2014-05-14 RUT Resistance

 

The story is less clear for the NASDAQ and the small cap Russell Index.  The NASDAQ actually held today, but the Russell hit resistance and sold off.  Many are betting on more downside.  But what is clear is that divergence will continue for the time being.

The longer term question is, of course, what will happen going forward?  If you look at the history of the S&P versus the Russell, they have traded in tandem for the last decade.  But, back in 2000, the Russell dropped while the S&P went on to new highs.  So, that scenario is less likely, but still possible.

Best Practices: Why Is the Bond Market Rallying?

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On Friday, bonds rallied in a big way.  The interesting thing is, not even the professionals are sure why.

Before we dive deeper, it’s worth looking at why this question is important.  The bond market is much larger than the equity market and usually, they move in opposite directions.  When investors are concerned, they take money out of stocks and put it into bonds, making the prices of bonds rise.  The interest on an existing bond is fixed, so as bond price rises, the yield on the bond actually falls.  In the opposite situation, when markets are doing well, investors take money out of bonds and put them into stocks.

That’s the usual correlation, and that’s why investors are worried.  Despite the relatively positive employment number, bonds rose, which implies that the market is worried about the economy.  Fact is, bonds have been trending up for some time, so if anything, Friday’s move seemed to confirm the upward trend.  Bond investors are usually longer-term fundamentally-oriented, so many believe that bond investors are usually right in the long-term.  At the very least, stock investors are wondering what bond investors know that equity investors do not.

Is there a rational explanation for this divergence?  A number of explanations were put forth on Friday.

One is that investors were afraid of action by Russia over the weekend.  This has probably been a driver of the recent bond rally.  It is, in fact, a driver that is not likely to go away any time soon.  But, it’s not clear if this the major, or the only reason.

A second explanation is that bond investors were short going into Friday’s employment number.  The idea was, a better-than-expected jobs number would confirm that the economy was on track in its recovery.  This would cause investors to take money out of bonds and put it into stocks, leading to a rally in equities.  When this didn’t happen, the shorts had to cover their short position and buy back bonds, causing a rise in bond prices.  Personally, I do think this was a factor on Friday, but it doesn’t account for the long-term trend.

A third explanation for the recent rise in bond prices is that Fed tapering is actually shrinking the supply of bonds.  The Fed is printing less, so the actual supply of bonds is falling.  This does make sense to me and has likely been a factor.

The last, and most worrisome reason for equity investors, is that the economy is weaker than thought.  This may be, in fact, true.  Thing is, we won’t know for a while and in the meantime, the signals are mixed.  One possibility is that many investors are buying bonds just to be safe – they aren’t sure about the world economy, and they would rather sit in bonds and wait than take risk in equity markets.

Personally, I think all these are true, but that the last is the biggest driver of the recent bond rally.  As I’ve mentioned in previous blogs, many believe that this summer will be weak and that a rally will occur at the end of the year.  That doesn’t give many investors reason to hold stocks over the summer.  Given that Russia, China or Japan could cause worldwide concerns at any time, investors may be thinking about caution more than about potential gains over the next few months.

I am long the TLT.

Marketwatch: Markets Keep Us Wondering

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Oddly, my last several posts were not published, although I thought they were.  Not exactly sure what happened, but my apologies for those that follow the blog.  Very sorry about that.

As a general rule, I’ve found that markets like to keep us guessing.  We are forever in search of clarity, but the market rarely gives us what we want.

And so it is now.  We have two indices – the S&P and the DOW, that look great and look like they will roll into new highs.  We have two other indices – the Russell (small caps) and the NASDAQ, that have been rolling downhill.  Normally, bonds rise as markets fall, but the S&P and the DOW are rising and bonds are also rising.  In short, there’s lots of divergences and confusing signals.

I will say this: it is quite possible that we head for new highs.  The bulls will make some fundamental argument about how things are actually quite good and that the economy is progressing quite nicely, albeit slowly.  Still, if we hit new highs, I don’t think that’s the reason.  We’ve had dips, but just as a matter of observation, the dips in the S&P have been bought – and quite quickly; almost violently in fact, meaning that the dip doesn’t last for very long.  To me, that signals bullish sentiment, at least in the S&P and the DOW.

The other consideration that seems important to me is this: markets are often set up to hurt the most people.  If you think this way, which is a bit contrarian, then the most logical direction is up.  Many are positioned with hedges because they’re worried and pessimistic about the mixed data, such as weak GDP, weak earnings growth and signs that the real estate recovery could be stalling.  Many are also positioned short because of all the selling in the NASDAQ and the Russell.  If the S&P and the DOW both continue toward new highs, that would drag the NASDAQ and the Russell into at least a short term rally.  This would wreak havoc on many shorts and those who bought downside protection.

One more note – if you do think this way, the most logical course is for markets to rally, which hurts many, and to sell off quickly after, because at that point, everyone will have been forced to remove their hedges, and all the shorts would have covered.

In terms of markets, the NASDAQ and the Russell are now at a temporary pause or bounce after several days of selling last week and the beginning of this week.  Because of that, we have a scenario where, if we get good news in the next few days, all the indices could, in theory, move upward.

Is this likely to happen and should the investor position for it?  Of course, impossible to say.  Any outcome is equally possible – we could rally, we could continue to churn, we could fall further.  We have no way of knowing.  But, we must make a decision.

For me, I am staying long stocks that I think are more likely to hold in a downturn.  ETFs are also good here, because they won’t fall as fast as some individual stocks, but keep in mind, they won’t rise as much either.  The sectors that have been doing well – value, old tech, energy – are likely to continue to do so as well, because they are still considered relatively inexpensive.

I’m also taking off positions that could hurt me if the market runs up very quickly.  For the S&P and the DOW, the most likely case seems to be upward or sideways churn.  For the NASDAQ and the Russell, we have a very short term bounce that is only likely for a few days.  After that, those indices will run into resistance – which we may go through, but we will have to see.

For the S&P, I have a short term target of 1894, which is 10 points away and the 1.27 extension of the last swing.  We could see a pullback after that, or, if we push to new highs, then the target would be 1924, the 1.27 extension of the swing from the last high of 1897.

One final thought – we have a jobs number this Friday, which always adds a bit of volatility.  Because of that, we’d have to be prepared for the possibility that a good number, especially one that indicates the winter weakness was indeed due to weather, could push us upwards.

I have long and short positions in the S&P.

Marketwatch: A Very Bearish Week

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Obviously, Friday was bearish for markets.  Many, especially CNBC, blamed it on Russia, while others just called it rotation.  I think it’s more than that, for several reasons.

The main one is that this week, markets rallied into resistance and sold off quickly.  This is generally a bearish sign, but more importantly, many indices failed exactly a downward trendline.  This, more than anything confirms the downtrend in those indices.  It also makes it harder for the rally to resume in these indices.

The question then becomes, who is going to buy?  Who will step up?  It seems like it’s getting harder to find buyers.  Many, including me, were surprised by the selloff in Facebook (which I am long).  Despite what almost all considered an impressive quarter, the stock sold off considerably.  Likewise, Netflix, which showed growing international numbers, sold off on news that HBO was going to be allying with Amazon for internet distribution of older HBO shows.  One might expect a decline on this news, but the important thing is that (1) the new wiped out any gains from the earnings news; and (2) the selling continued in the following days.  On Friday, almost all sectors except utilities were down.

As noted in my last post, a downward correction starts with a rotation.  I said that the rally could resume if buyers stepped into the failing leading sectors.  This week proved that buyers are still selling the former leaders.  In this situation, the new leaders have to rise even more to keep the rally going.  I’m highly skeptical that the new leaders – energy, old tech – can continue this rally alone.

Let’s take a look at some charts that demonstrate the points discussed above.  Here’s the S&P:

Screen Shot 2014-04-26 Blog Post SPX Bearish

 

Regarding the SPX:

1) In previous posts, I noted how the S&P bounced off a triple bottom.  Here, they rallied to the 1.27 extension (127%), which was resistance and sold off.

2) Notice how in Thursday,  the S&P sold off sharply as soon as it hit resistance, followed by more selling the day after.  This is a common sign of bearish conditions.  In a more bullish environment, the market rallies to resistance, but is more likely to hang around resistance or to make several clear attempts before reversing.

3) As mentioned in the last blog, we may have the beginning of the right shoulder of a reverse head-and-shoulders formation, which is classically bearish.  We can’t really say it’s certain, and the market may still push against resistance.  The key is whether the market fails at a high lower then the last high.

4) For the short term, we are looking to see where the S&P will find support.  The most likely support area is the 61.8% area, though anywhere from 50% to 78.6% is possible.  Below 78.6%, the probability of failure increases dramatically.

The S&P and the Dow are the strongest of the indices.  But to see the current bearishness, the NASDAQ is a better view:

Screen Shot 2014-04-26 Blog Post QQQ Bearish

You’ll see in this chart that the NASDAQ, as represented by the QQQ, fails decisively at the white downward trendline at about $88.50.  This also coincides with the 50-day moving average (blue dashed line).  This failure indicates that bearishness in the NASDAQ is likely to continue.

The thing is, many sectors look exactly the same, especially the former leaders – healthcare and small caps (Russell index):

Screen Shot 2014-04-26 Blog Post XLV Bearish

Screen Shot 2014-04-26 Blog Post IWM Bearish

In my opinion, this week signals a resumption of bearish conditions.  This doesn’t mean we’re headed off a cliff, by any means, only that the probability of new highs in the short term is falling.  As as more sectors continue to decline, we need more and more reasons to head back in the other direction.

I hold positions in the SPY and the IWM.

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