Violence in the Middle East Triggers Some Downside

The last time the stock market had a bad was Friday, January 28th. If you will recall, that was the day traders decided to focus on the growing unrest in Egypt. Granted, it was an options expiration Friday and traders were looking to avoid any potential headline risk over the weekend. However, the Dow fell 167 points and suddenly everyone on the Street was bearish.

On that day, you couldn’t really blame traders for jumping on the bear bandwagon. After all, stocks had been marching steadily (some might say relentlessly) higher for weeks on end and every trader who had ever looked at a chart knew that things had gotten a little extended. As such, even the most ardent bears agreed that a pullback was due. The only thing missing was a catalyst to get the bear party started.

So, with violence erupting in Egypt and people’s attention suddenly drawn to the strife that was occurring in the Middle East, it made sense that the fast money types would quickly switch from long to short. And at that time, the only question was how low the indices could go.

But if you will also recall, the decline seen at the end of January wound up being a one-day wonder as traders quickly realized that Egypt didn’t have any oil and that the civil unrest wasn’t likely to have an impact on the earnings of Apple (AAPL), GE (GE), or Caterpillar (CAT). And before you could figure out whether or not the U.S. supported a regime change in Egypt, the indices were back to dancing merrily higher on a daily basis.

If any of this is sounding vaguely familiar, you are likely wondering if Tuesday’s 178 point dance to the downside is a case of déjà vu all over again or the start of something more meaningful. Stocks had basically been marching higher each and every day since the last go round with the Middle East. Once again a pullback was overdue. Once again, sentiment had become more than a little too one-sided. Once again, the bears needed something to trigger some downside action. And once again, it was violence in the Middle East that gave the bears something to work with.

Our furry friends will argue that Libya may matter a lot more than Egypt for the simple reason that it pumps a whole bunch of oil out of the desert on a daily basis. Granted, Saudi Arabia has more unused excess capacity than Libya is capable of producing in total and as such, even a complete shutdown of oil production in Libya isn’t going to impact world supplies. But the key here is said to be the risk of contagion in the region.

So, with talk about which country could be next and whispers that Saudi Arabia might be high up on the list (okay, that might indeed pose a problem to the global economy), traders decided it was time to move to the “risk off” mode. And just like that, the indices wound up searching out the nearest support zone.

For the Dow, it appears that 12,200 is some sort of line in the sand. While we wouldn’t call it an important support zone, the level does seem to provide some signs of support from a short-term perspective. The only problem is there are no such corresponding levels on any of the other major indices. As such, one could argue that we could see the bears try to explore the downside reaches in the coming days while the bulls decide where to draw the line and put up a fight. Therefore, we would suggest that some backing and filling might make sense right about now.

But it is also important to keep in mind that the modus operandi for the bull camp has been to buy each and every dip in prices – regardless of the dip’s duration. Thus, one could argue that unless and until this mentality changes, the bulls will retain possession of the ball. However, given the fact that all good things come to an end (eventually) in the stock market, the question of whether or not this is déjà vu all over again remains unanswered this morning.

Turning to this morning… It appears that the bulls are trying to draw the line at yesterday’s lows and will look to see if they can convince the buyers that yesterday was once again a one-day wonder.

On the Economic front… We don’t have any economic data to review before the bell, but we will get the report on Existing Home Sales at 10:00 am eastern.

David D. Moenning
Editor: The Daily Decision