Market Bracing For More Tech Downside
- Not enough good news from AAPL, IBM to withstand financial sector results and a sense that this second leg of the rally may have run its course.
- December housing starts sag but permits rally: builders may be a bit too excited a bit too early.
- Late bounce provided a bit of positive tone after the indices test the 127% extension breakout, but after Wednesday, the action very much resembles the market in early November.
- Market bracing for more tech downside as after hours earnings snowball downhill.
MARKET OVERVIEW
Tuesday night the trading rooms and financial stations were buzzing over IBM’s and AAPL’s outstanding earnings. After all of the superlatives the real question was whether the two, up after hours, would hold the gains and lead the market higher after a mediocre session.
That question was not even decided in the pre-market as futures were modestly lower, but nothing major. Soft starts can be a positive, and if so the market was setting up for a positive. After all, both GS and WFC reported in line results and they were getting boxed around pretty good in the morning, but the strength of the tech duo provided a counterbalance to the financial downside. At least enough of a counterbalance to hold futures flat to slightly positive.
That held to the open, but as the bell sounded stocks slid. They sold through midmorning, the typical fulcrum for the day, the point where you look for the market to take its direction at least through the start of the afternoon session. It did. Just over an hour and one-half into the session the buyers made their move. The first attempt was pushed back but then a stronger bounce ensued. It looked almost decent for 40 minutes or so, but then it gave way.
When the midmorning market turn attempt failed, that unleashed the dogs. The rest of the session was more of the same, i.e. downside, rebound attempts that found no traction, then further selling. That lasted into the last hour with the indices falling 1% to 2+% each (other than DJ30 with its 0.11% loss thanks to IBM) even with a modest bounce late in the session.
Late bounce holding any promise for Thursday or is this November again?
Now that late bounce had some hopeful that the market could hold the line given the indices were bouncing off, more or less, the 10 day EMA and the 127% Fibonacci extension broken last week. It makes perfect sense that the indices would come back to test that level, and the late bounce up from the test suggests that they could be doing just that.
Maybe. The viciousness of the turn, at least in some stocks, would argue otherwise. There were more than a few engulfing patterns, i.e. where a stock’s move the prior session is completely swallowed or engulfed by the high and low of the next session. That is a very bearish indication, at least for the short term, suggesting downside near term for those demonstrating that pattern. Indeed you can argue SP500, NASDAQ, and SP600 all show this bearish action.
It has been a solid and rather long second leg of the breakout. Not quite as long as the August to November run, but it is quite respectable. SIMILAR to the November action that marked the peak of that run, this market moved laterally at a resistance point and then gapped upside through that resistance. After the gap the move held its own, adding to the gain until five days later (four days in November) there was an engulfing pattern. In November that preceded the three week pullback/correction/consolidation.
The action is very similar here: a solid rally off a pullback, the rally took it to the next key resistance point. It slowed and measured the resistance then broke through with a solid move. When it looked as if it was going to hold the break it was followed by a sudden and sharp break downside. Throw in it is earnings season, that last season investors rallied stocks into the fourth week of results, and that this time they don’t seem quite as enamored with the reports, this Wednesday action could very well presage a similar pullback.
So that is the end of the rally, right?
Was that November correction carnage? Hardly. Stocks rallied straight up for 9 weeks. They needed a break. The indices spent about two weeks finding the bottom and putting in a higher low. A second higher low was made for good measure and they were off to the upside once more.
Remember, before that August rally and November pullback the indices had put in a base spanning late April 2010 through September. The last low was put in late August, but the April peak was not officially cleared until early November. That was the break over resistance that prompted the correction and set the stage for the second leg of the rally. That is a very impressive base that sets the foundation for further moves, not just a couple of initial runs. After all, if the economy is recovering and growth is going to continue increasing, this is the kind of base that allows stocks to run not just once, not just twice, but 3, 4, even 5 times before needed a longer, deeper correction.
They have rallied 7 weeks on this move. It is the second run since the August higher low that set the right shoulder of the summertime inverted head and shoulders pattern. A correction similar to the November pullback would not mark the end of the rally, but would be rather normal for any index or stock that found itself similarly situated.
There is still plenty of leadership. There is rotation into new areas giving rise to new leadership. Yes some sectors that took the point are struggling as money moves out of them, but it is not a collapse. Instead it is more like recycling them, allowing them to base and consolidate strong runs to allow them to run again down the road. Leadership is what makes any market rally, and even with the recent leaders in financial sectors pulling back some, we suspect they will be right back in the mix shortly, helping SP500 rally once more.
Too bullish? Could be.
That is a pretty bullish scenario and it goes against our nature to be overly optimistic about any move. It cannot last forever and it won’t. Thing is, the Fed told us this week that it will still make its bond purchases even with the signs of economic strengthening and thus we know that for now the liquidity bid will remain.
That liquidity bid won’t stave off corrections, but it certainly makes the upside quite lucrative and it also tends to truncate the downturns. At some point it ends, i.e. the Fed’s liquidity just cannot be absorbed by the financial markets anymore. That of course would spark massive inflation in addition to what the economy is growing right now. If the Fed stays in the game too long the result is ugly. When it pulls out, if the economy is not able to sustain itself due to the continued massive debt shackling everyone and every business or for a multitude of other reasons, the result is ugly as well.
UNTIL then, however, you take what the market gives and with good current leadership and a good base behind the indices, that looks promising for another run upside after this correction/test/consolidaton.
Jobless claims are out of course but so are more earnings. After hours FFIV, a tech high flier, gave in line results and guidance that didn’t blow everyone away. So, investors are blowing it away after hours with the stock lower by rough 30 points or -22%. The coattails of its miss are taking many tech stocks. Futures are so-so while Asia is down from 0.5% to 1%. Not carnage, but it could set up another weak session.
That would make perfect sense for a correction in the market. As noted the action is similar to November, so the platform is there. With earnings having tougher comparisons and the last round of earnings giving stocks a month-long boost, it looks as if they are taking it out on companies this time around and Thursday is going to be the same only apparently intensified.
Wednesday we were taking positions off the table, using some fairly tight stops to preserve gain, and we will continue to do the same. We also moved into some downside positions and will continue looking at those as well. The last correction was pretty quick in terms of hitting the bottom. Not all pullbacks are the same and this one may not even materialize. Based on the action Wednesday we anticipate more downside and will handle it with stops, downside plays, and if the upside holds support, we let them move as well. Of course if this is a pullback just as in November, we will get upside buying opportunities as well.
Before that (buying opportunities), there is likely to be more downside. Again, we will let those that hold support run while taking care of those that struggle. At the same time we look at downside plays to make us downside money in the interim. Take what the market gives, and right now it looks as if there is a bit of downside early on.
Jon Johnson
