Failed Breakout – Still Some Downside Next Week. SPY $165.75 Should Hold Today

August 16, 2013

Today’s comments were published before the open. Yesterday, the market broke horizontal support at SPY $167. That is significant because it represents the breakout in July. Traders that bought that breakout are now getting flushed out. The news Thursday did not justify the decline and this is nothing more than a round of profit taking on light volume. Once the momentum was established, the move was tough to reverse.

Asset Managers pulled bids as bullish speculators hit the exits. This resulted in the “air pocket” I’ve been referencing. Once this wave of selling runs its course, the bid will resurface.

Asset Managers won’t chase stocks at an all-time high, but they will buy dips. That means any decline will be relatively shallow and brief. I believe we could retrace to the middle of the trading range (SPY $163).

Earnings season is winding down and retailers are reporting. American Eagle, Wal-Mart, Macy’s and Nordstrom’s have all disappointed. Consumers are postponing back to school purchases. This sector has been very weak in recent days and the bad news is priced in.

Overall, year-over-year earnings growth on the S&P 500 was negligible in Q2. Asset Managers are focusing on record cash flows.

Corporations are using their money to buy back shares. I recently read a study that suggested that half of the entire float has been retired in the last 10 years. Constant demand and lower supply results in higher prices. This alone can justify the rally and I don’t see this changing.

Economic conditions in Europe, China and the US are improving. The Fed will taper and traders are still trying to come to grips with that fact. The four-week moving average for initial jobless claims is at its lowest level in November 2007. Yesterday’s claims sparked additional selling because traders believe the Fed could act as soon as September.

From my perspective, we need economic growth to fuel this rally. Rising interest rates are not a problem as long as they are accompanied by economic growth. Corporations are lean and mean and any uptick in demand will go straight to the bottom line.

The selling this week is nothing more than a normal correction. I mentioned yesterday that I would short the market on any bounce. When we rallied back to SPY $167, I entered bearish positions. I was able to take nice profits near the close. I also mentioned that swing traders should focus more on future buying opportunities. Once this wave of selling runs its course, the better move will come on the rebound.

The calendar is very light and flash PMI’s (Wednesday) are the only release of interest. Stable activity in Europe and China will attract buyers if the market continues to slip. Once that news is out we are dead until Labor Day.

Light volume markets are difficult to trade. Most of yesterday’s move came in the first hour. After that, we fell into a tight trading range.

The market will try to rebound this morning. I don’t believe buyers will be very engaged and resistance at SPY $167 should hold. If we rise above it, I will buy calls. The more likely scenario is that the early rally will fail and we will probe for support. We should find it at SPY $165.75 (50-Day MA) and the market will claw its way back to unchanged for the day.

We still have some work to do on the downside, but I would keep bearish positions on a very short leash. I would not hold shorts overnight – the bid is too strong.
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