Traders Fear That the Punch Bowl Will Be Taken Away. Support Broken – More Selling Ahead.

June 5, 2013

Yesterday, the market looked poised for recovery. We’ve seen a little profit taking over the last week and bullish speculators have been flushed out. The market rallied in the first hour and it looked like we would rebound.

The mood changed quickly and that early rally led to a sharp decline. When buyers failed to step in the second shoe dropped. The SPY broke support at $164 and the lows from the week were tested. This is a clear sign that there is more work to do on the downside.

Stocks are probing for support and we are making a new relative low as I write my comments. This could be the start of a correction and the price action this week will be pivotal.

I’ve been mentioning that traders could get nervous ahead of major releases this week, but this is something more. ISM manufacturing missed estimates and ISM services beat. These two numbers are a wash. ADP came in light at 135,000 (157,000 expected). Last week durable goods orders, GDP and Chicago PMI came in mixed. All of these numbers are consistent with a Goldilocks economy. However, the tone has changed.

Traders are spooked by the Fed. They feel that soon as economic conditions improve, the punch bowl will be taken away. Bullish sentiment has been off the charts this year and higher interest rates could spark a decent correction (10%).

In the long run, higher interest rates are good if they are accompanied by economic growth. The market simply has to adjust to the change. Yields have been falling for years and sooner or later, that has to change.

The reality is that the Fed won’t do anything stupid. They will simply reduce purchases (taper) when economic conditions improve. They still plan to carry a huge balance sheet well into the future and they will not become net sellers.

The Unemployment Report should be in line with expectations on Friday. Initial jobless claims have been steady during the last month. Keep in mind that a good number (strong employment) could actually be bad for the market because it might prompt the Fed to taper.

I sold out of half of my call positions yesterday afternoon when the market failed to recover. I sold my remaining call positions this morning when the market made a new relative low. I will be day trading and I will buy puts if the market closes below $162.60 today. If the market closes back above $164, I will buy calls.

Look for choppy action today. This is a good time to stay on the sidelines. Watch the levels I just outlined and take appropriate action. The news this week will determine the direction for the next few weeks.

My gut tells me we are heading lower. Major support is at SPY $159.
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