There's a Little Panic For Ya!

Oversold Market Sees Some Relief 

We finally saw some support come in for the market after trading to quite oversold levels. The SP500 Sector Stocks made new two-year lows this week, which tells me two things:

1. It says that the SP500 is likely due for a relief bounce

2. It also says that under the surface strength is the lowest its been since 2012.

What this amounts to is that the market is behaving like it should during a downtrend. We are just scratching the surface of what a downtrend is all about. Who knows, maybe we did form a long-term bottom this week and we just rally right back to new highs. However by looking at the individual stocks from my watchlist it appears that this is simply a throw-back move into the prior support levels.

SP500 weekly

The weekly bar chart of the SP500 shows the trend channel from the 2009 lows. For the past year the SP500 has been trading above the upper boundary of this channel. Typically this is unsustainable action and the price will revert back to the original trend. This week's action penetrated the upper boundary, now uptrend support, but managed to close right back at the line.

The Daily view show the action zoomed in at the trend line:

SPY daily

On Wednesday we saw the market gap below the uptrend line which seemed to cause some heavy selling and a bit of panic. Wednesday morning marked the low for the week and price has since rallied back to the broken support. As you can see above, even though we saw a decent save attempt, price is still stuck below the polarity resistance near 1,900 (or 190 on the SPY shown above).

Also notice that as soon as the market began to roll over and pullback volume began to increase and persisted to grow almost each day into Wednesday's low. I think short term the selling has exhausted itself, but the rally back into resistance levels has seen volume decrease each subsequent day. Typically in a downtrend volume will accelerate with the trend and then be reduced on any counter trend bounce attempts. Classical technical trading tells us that low volume bounces are suspect and prone to failure. The low volume rallies haven't mattered or been bearish since QE took over the market, but with QE now a non-factor we may see behavior revert to more classical rules.

Just as with uptrend breakouts (which will often pullback and "re-test" the breakout area), downtrends will bounce and re-test the prior support levels. The principle of polarity in supply and demand tells us prior resistance becomes support in uptrends and prior support turns into resistance during downtrends. Since the market has recently broken below support we would expect price to rally back to see if the prior support now becomes resistance. The thing we need to watch for are if stocks can begin to reclaim their prior support, that will be the first sign that maybe a bottom is in fact in for stocks.

It is my view that the market is in the middle of a 5-wave decline on the Daily chart and we are seeing a wave4 counter trend bounce now. A wave5 washout should occur over the next couple weeks.

VIX and TLT Signal Initial Panic Wave 

Two reliable measures of investors intentions and sentiment showed initial panic moves this week and that also supported a short term relief from the selling. The VIX measures fear in the market; the VIX is the ratio of negative bets vs positive bets made by options traders. When the VIX rises it signals that more bets are being made against stocks going higher than for them. Similarly Treasury Bonds are considered one of the safest investments available, when we see large rallies in the bond market it means investors are seeking shelter from riskier assets.

Both of these groups saw tremendous inflows on Wednesday morning. The VIX spiked more than 30% while TLT rallied over 5% after the open of trading. For those new to the market a move like we have seen in treasury bonds since 2014 is a BIG move. There have been larger spikes during crisis markets, but TLT has rallied 20% this year. 20% is a lot for any market, especially bonds! So not only have we seen a strong steady rally in bonds for a year, but Wednesday morning gained more than 5% which is a quarter of the entire yearly gain. Needless to say investors were getting a little panicked and overstuffing the "fear" shelters.

I believe we saw a bit if a washout of over-speculative investors and were due for some bounces in stocks. Since Wednesday morning the SP500 is up 70 points off the low.

Intermediate term though these defensive setups are both poised for higher levels, which likely means more trouble for the stock market ahead.


TLT daily 1-year

Fortunately we were watching for a target acquisition near $124 for TLT and Wednesday morning we were able to take advantage of the surge and lock in some nice gains. I have been highly exposed to Treasury bonds since early 2014 and used the pop Wednesday morning to reduce my exposure by 30%. I am still at a 10% holding level across my accounts and I believe we could eventually see upside to the $132 level. I will then be taking another 30% off on that potential acquisition.

TLT weekly

This is classic "blow-off" type action happening in TLT. We have seen a prolonged rally fueled largely by the "rising rate environment" mentality. The unwind of that kind of sentiment can be long and impressive when it finally breaks the last of the bearish bettors. That's when you see these "i give up" type moments; I believe we saw one of those moments this week.

Looking at bonds here I believe that they move lower over the near term, but intermediate term the trend is still well intact. Stops should be trailed up to the rising 20 WMA near $115.

VIX (Market Volatility Index)

While I don't trade the VIX I do find it a valuable tool to measure sentiment in the market. Spikes in volatility have historically marked bottoms for the stock market. Wednesday's move looks like a very nervous spike. The VIX easily saw its highest reading in 2 years:

VIX daily- with spike and throw back

Looking at the daily chart you can see Wednesday's huge surge followed by two days of swift reversals. With the VIX above 20 (warning level) after the throw-back attempt, it looks like we are seeing an important breakout in volatility that we have not seen in some time. Whether it can hold above 20 is yet to be seen, but the longer it stays elevated the more likely another spike in fear will be.

VIX weekly- looking at prior peaks

Taking a longer term look at the VIX you can see where the prior peaks have been and how this one compares. There are a couple things you can take away from looking at the longer term chart. First you could say we have a lot further we could go before equalling the fear we saw in 2009, '10, and '11. That would be the negative outlook. That we have broken the 2 year downtrend and are now entering a more pressured market environment.

OR

You could look at these peaks and say that we still have a long-term series of lower highs and lower lows, and that Wednesday's spike is the end of this little stumble.

Its impossible to know how this will play out but in my opinion we need to watch how it behaves around the 20 level. If it just flops right back below 20 next week I would say the move is probably over and stocks move back to highs. If however it just hangs out above 20 then I would think a much deeper correction for stocks is ahead.

Both the VIX and stocks showed breakouts/breakdowns and then subsequent throw-backs to key levels. The most important thing to do is keep an open mind and just be ready depending on whichever way it goes. 

Portfolio Review

Despite the action this week we saw little change in our Portfolio. Most names bounced around a bit, but we received no new Exits. How you are reacting to this correction depends on your investment timeframe; my more aggressive accounts are mostly all cash currently, I lost a couple holdings this week but most of the cash was raised over the past month. My more conservative accounts (like the Blog Portfolio) focus on the weekly timeframe and they remain roughly 40% stocks, 10% bonds, and 50% cash.

If you only looked at the positions in our portfolio, you might actually think the market is on quite solid footing. Its when you look at the other 70 SP500 Sector Stocks that things don't look so rosy.

 KO

NKE

Stop: 20 WMA and just below the breakout level

UNH

Stop: Weekly close below this week's low price.

BRKB

Stop: Below $130.90

GS

Stop: Adjusted to $175.50 or just below the rising 20 WMA

BMY

Stop: Near $49 

HAIN

Stop: 20 WMA and breakout level ~$93

GILD

Stop: 20 WMA and below $93

Our stocks are performing very well relative to the overall market and are all still in clearly defined uptrends. These are what leading stocks look like. While the market is correcting substantially, these leaders are very near their highs. If the market finds its footing here these will be the stocks that break back to new highs and they are the ones you want to focus your capital on.

While our positions look healthy, participation in the broader market uptrend is waning significantly. Of the 90 stocks I track for our watchlist, 27 remain in uptrends (Above their rising 20 WMA's) and 63 are below and making lower lows. This is not a good ratio and if we are going to see any sort of sustained recovery to new highs there is going to need to be much more participation from the underlying stocks.

It is a "market of stocks". Meaning if the health of the individual stocks that make up the market begin to weaken, it is only a matter of time until the market as a whole succumbs to the negative pressure.