The technical picture could be at an inflection point. Today’s price action will be very telling.
I don’t like the second selloff in 10 days off of a relative high. The interval is very short and this selling needs to quickly dissipate. If it does not, it could be a sign of resistance. I won’t pass judgment until I watch the price action this morning.
There wasn’t much news overnight to justify this decline. The market will probe for support in the first hour. We could see a deep trough and we are already below support at SPY $181.50. What happens after that is critical. If buyers step in and we snapback, the table will be set for a nice rally. This decline will mark a capitulation low and the focus will shift back to earnings.
If the market probes for support and the bounce is shallow, we will see afternoon selling and we will close on the low. This would be bearish.
In a matter of days every analyst and guest on CNBC is calling for correction. Here are the themes: growth in China is slowing, a Chinese high-yield financial product could default, the Fed taper is pushing emerging market yields higher, Argentina and Puerto Rico could have credit issues, politicians are digging their heels in over the debt ceiling, earnings growth is slowing and the market is overdue for a correction.
Let me start with the biggest threat to the market. Credit concerns can flare up at a moment’s notice and this rally killer needs to be monitored constantly. I don’t see this as a current threat. PIIG’s yields are at multi-year lows and central banks are printing money. Argentina and Puerto Rico might have issues, but their impact (unlike EU members) is relatively contained.
Growth in China has slowed, but it is still 7.7%. The PBOC injected liquidity earlier in the week when GDP, industrial production and retail sales missed by a small margin. Their target is 7.8% and they will jump and action if conditions deteriorate. The financial product that might fail is tiny ($500 million). Now China might bailout investors. Stocks in China finished higher overnight.
The soft numbers in China are more than offset by a rebound in Europe. This news has been swept under the carpet this week. I feel the EU could be a huge catalyst for global markets in Q1.
The Fed is tapering. Now that their intentions are known, there is a ripple effect. Emerging markets are going through an adjustment and rates will eventually stabilize.
Earnings growth is slowing. It has decreased from 7.5% to 7% this quarter. However, some of the strongest companies have yet to release. Apple, Boeing, VMware, Yahoo, Amgen, Biogen, Google, Facebook, Amazon and a host of others post results next week.
Earnings growth might be slowing, but profits will hit record levels. Companies are lean and mean and cash flows will also hit record levels. Buybacks will continue and that has been a powerful force in the last year.
As bad as the current price action seems, the S&P is only down 1% for the year and the NASDAQ is still in positive territory.
The market tried to break out twice and it failed. When it couldn’t move higher, traders tested the downside. Bullish speculators have been flushed out.
We’ve had a weak round of news, but it hasn’t been horrible. Retailers are struggling, but consumers are spending online (AXP said spending was up 8%). The jobs report was a fluke and initial jobless claims have been falling the last few weeks. The Fed will not taper if it sees deterioration.
I can’t ignore the technical weakness. If the market does not bounce this morning and we drift lower the rest of the day – exit call positions. A close below SPY $181.50 would force me to the sidelines. I am not prepared to go short. I still feel macro conditions are bullish and any pullback will simply represent a fantastic buying opportunity.
If the market falls sharply early in the day and it snaps back, watch for a nice rally next week. Bullish speculators that got flushed out will scramble to get back in and bearish speculators will get caught on the reversal. Asset Managers will see that buyers have returned and they will snap up stocks as the strongest companies prepare to release earnings. I still feel this is the most likely scenario.
Take your cue from the price action this morning. After three hours of trading I expect to see SPY $181.50 hold and the market should not look back. Stick with long positions if this happens.