Gap Hunt

It was another ugly week for the markets. The SP500 declined -2.2% and is now back at the range lows. The setup from previous tests of the key support near 1860-1870 has been to rally sharply. Will we see this again? I think its likely that we get some kind of relief rally, how long it lasts is another story.

We have seen the SP500 decline 8% in two weeks to start the year. Its been a pretty brutal move and most regular investors were not prepared in any way for what has occurred. I'd like to say it will get better from here, but I honestly don't know if it will.

Something I watch for is the behavior of market moves. When there is selling this strong and this relentless, it's concerning. Another behavioral trait that is prevalent right now is the market's ability to seek out gap areas and fill them. We've seen three very sharp moves over the course of the last 4-months. Each move left many open gaps from the prior day's closing and next day's open. In range bound markets, gaps tend to be trade-to targets. Lets take a look at this behavior we've seen recently:

 The first decline in August left five unfilled gaps on the way down. As you can see the October recovery appears to be nothing more than targeted gap filling. The day following the high gap fill marked the top of the rally and we have dropped 240 points from there. Its worth noting that this Friday's decline filled the final gap from 8/25/15.

 The October rally also left five unfilled gaps on the way up. Those gaps have all been filled with the recent correction.

Now we look at the current decline which by my count has six unfilled gaps above. If the pattern is to remain the same we could expect a recovery to fill these open spaces. This gap fill campaign doesn't have to occur right away, it could take months or more to accomplish. But the recent trend has been to reverse and fill gaps within the range. If the lows hold near 1870ish, the range remains intact and a move back to the upper boundary is the next logical direction.

Something I watch for with gap behavior is "how" the gaps are filled. There can be strong risk/reward trades to be had when a gap is filled and then price doesn't reverse, but then breaks through the gap area. This creates a shift in sentiment and the moves can be powerful.

The opposite is also true if once a gap is filled and price cannot overcome the gap level, a reversal is most commonly the outcome. We saw this in both early October as the lower gaps were not overcome to the downside and price rallied, then also in early November when the upper gaps were not broken with higher prices and the subsequent decline played out.

What I will be watching for is confirmation of this tendency either through and below this 8/25 gap area or a reversal back through the open gap at 1922.

Key world markets are suggesting downside is not over 

While the SP500 remains in a trading range and at long-term support levels, many of the other major market indices remain in downtrends and below key support.

Russell 2000 Small Cap Index

The Russell 2000 Small Cap index has declined 20% in the last 7 weeks and is 30% off its highs from last summer. This is a risk-off indication as money managers are seeking more defensive investments.

Emerging Markets (EEM)

Emerging markets have been a total mess for more than 6 years. After a perfect technical throwback into multi-year support at $36, EEM has rolled back over to lows not seen since 2009.

Shanghai Composite (SSEC)

China has been the focus of the media for most of this volatility. The Shanghai index broke significant support this week after emerging from a bearish wedge pattern last week. This still looks like lower prices ahead and that will likely keep pressure on global market sentiment.

Japan Nikkei

The Nikkei is in a confirmed weekly downtrend and is clearly rolling over. A bounce is likely soon, but for now we have lower lows and lower highs.

FTSE London

The FTSE is another ugly chart suggesting more volatile and lower prices. On any rallies 6,500 should be a very formidable resistance. 

Crude Oil

Oil is probably the number one drag on sentiment and global confidence. It continues to make lower lows and everyone seems to think they can predict the bottom. We've been hearing "the lows are in" for over a year now and yet it continues lower. It pays not to try to be the hero. There will be fantastic opportunities to make money in the oil space in the future, but there is no reason to be the first one in. 

LG-Cap Portfolio Exits GOOGL, LOW and COST

Exiting GOOGL

Google followed through to the downside this week and looks to need some rest and consolidation. While the uptrend is still intact longer-term, its time for us to step aside with a nearly break even trade and wait for a better risk/reward.

Exiting LOW

Lowe's showed a second consecutive distribution week and closed below our confirmed swing low at $70. Relatively speaking LOW is still in fine shape, but it appears to need more time in this range before its ready to move on. We will step aside and await the next signal.

This should be a name we keep on watchlists. The horizontal base remains one of the better consolidations in the Large-Cap space.

Exiting COST

COST gave up its breakout and swing low this week. I still like this longer-term but its current posture is not too encouraging. The attempted rally to regain the 20 WMA failed strongly this week and again closed lower. This may need some time to rebuild support.

With these three exits this week our Lg-Cap Portfolio is now Long UUP, LMT, GE, and FB. We hold 80% cash and will need to see healthy price action and setups before we can redeploy our capital.

Something I found interesting as a side note is how my Growth Portfolios held up quite well this week in terms of exit signals. I only lost two names AMZN and CALD. That leaves NFLX, MKTX, COR, CUBE, TSN, FB, AMWD, ULTA and PBH. Those accounts remain 30% invested and 70% Cash, which surprises me some considering how vulnerable even the safest of Large-Cap stocks have been recently. We stick with leaders as long as they are viable and hey maybe the market turns here at support...Who knows? All we know is a few stocks are still holding up and could emerge as substantial winners in the event of a recovery.

Always keep and open mind and thank you for reading.

-ZT