Stocks are suffering with a multiple personality disorder. Two weeks ago stocks were up five days in a row with widespread gains. This past week stocks are down sharply four days in a row with a dead cat bounce on Friday. Financials, industrials, commodity-related stocks, and precious metals were all crushed this past week. The only real winners were bonds and the U.S. dollar. By the closing bell on Friday the S&P 500 was down -6.5%, the NASDAQ composite was off -5.3%, the small cap Russell 2000 index gave up -8.6% and the Dow Jones Transportation average had lost almost -10% for the week. It was the worst weekly performance for the market since October 2008 (almost three years).
What happened to the market? Essentially stocks crumbled under a storm of negative headlines and fears. Naturally Greece tops the list as investors continue to fret over a potential default. China was making headlines when they announced the third, consecutive monthly decline in its manufacturing output. Transports underperformed thanks to some bearish comments from FedEx (FDX) over their volumes. The Federal Reserve played their part. Wednesday was the conclusion of a two-day fed meeting and investors were expecting some sort of stimulus package. Unfortunately, the Fed only delivered a $400 billion "operation twist" of selling short-term bonds to buy long-term bonds. This had been expected so it was old news. Interest rates are already near record lows. Many analysts failed to see how putting more pressure on rates would help our stalled economy. Furthermore, Ben Bernanke's comments were not exactly inspiring, which suggested we're closer to a recession than previously believed.
Stocks began to sell-off in earnest on Wednesday following the Fed's announcement. The selling pressure picked up speed on Thursday when the Dow Industrial average was off more than -500 points intraday. Volume was huge on Thursday and down volume beat up volume by a margin of 50-to-1. Volatility spiked back toward its highs and is currently back above the 40 level. Big investors continue to pour money into the safety of bonds and the yield on the U.S. 10-year note hit a record low of 1.7% late this week.
One surprise this week was the sell-off in gold. You would have thought that with stocks in sell-off mode that gold would be in rally mode. Instead gold was correcting. There were rumors that the CME would raise margin requirements on gold and precious metals. Gold fell more than -$100 intraday on Friday. Silver plunged and copper fell into a new bear market (-20% off its highs). Sure enough, after the closing bell on Friday the CME did announce new margin requirements, which would suggest the news had been leaked.
Another contributing factor to last week's market-wide sell-off was analyst downgrades. Moody's was especially busy. On Tuesday Moody's downgraded Italy's debt, which isn't that surprising given Italy's economic woes. On Wednesday Moody's downgraded Bank of America (BAC), Citigroup (C) and Wells Fargo (WFC). Then on Friday Moody's downgraded eight Greek banks. What surprises me is that the Greek banks still had a rating that had room to be downgraded further.
Greece & Europe
Headlines out of Europe will continue to dominate the markets. This weekend the G20, the IMF, and the World Bank are all holding meetings to address the financial problems in Europe. Last week Germany was supposed to vote on changing the European Financial Stability Fund (EFSF) but it was postponed to this week. As the main economic engine for the EU region Germany's vote is critical for the EFSF. If the EFSF gets upgraded then Germany's bill for the rescue fund will increase from 123 billion euros to 211 billion.
German Chancellor Angela Merkel was trying to drum up support claiming that a Greek default could not be permitted due to the unforeseen consequences and potential contagion to other struggling economies.
In what will surely be another overhyped meeting the Greek Prime Minister, Mr. George Papandreou, will travel to the German capital on Tuesday to talk with Merkel.
I am very concerned about the major U.S. indices. The sell-off this past week is a bearish breakdown on multiple levels. The S&P 500 has broken below its September lows. Plus, the plunge on Thursday looks like a breakout from the huge bear-flag pattern we've been discussing. This sets up for a drop toward the 1,000 level. It's not going to get there all at once but the path of least resistance is down. The selling managed to stall at support near the August lows but there was almost no volume on Friday's dead-cat bounce.
If the S&P 500 index can bounce from its August lows (again) then it might morph into a bullish double bottom pattern. However, the bottom of the bear-flag is now resistance. I would be concerned that any bounce is going to roll over under 1150-1160.
Bear Flag pattern on the S&P 500 index:
Weekly chart of the S&P 500 index:
The NASDAQ composite has broken one trendline of higher lows but it looks a little bit healthier than the S&P 500. Unfortunately, we still see a bear-flag consolidation pattern. While a bounce near its August lows is likely it may end up being a speed bump on the way down. Of course the breakdown hasn't happened yet but the larger trend is not showing any strength. Currently the bear-flag would be suggesting a drop toward the 2100 area.
Daily chart of the NASDAQ Composite index:
Weekly chart of the NASDAQ Composite index:
Small cap stocks were underperformers last week. That's not surprising since they are normally more volatile than the large cap stocks. Unfortunately the sell-off is a breakdown from the bear-flag pattern. That sell-off has stalled at support near the August lows. A breakdown under Thursday's low would suggest the $RUT has begun a new leg lower. The 600 level will probably offer some support but the flag pattern is forecasting a drop toward 550 or lower.
Daily chart of the Russell 2000 index
Weekly chart of the Russell 2000 index
We have a busy week of economic data. The main reports to watch are the Durable (goods) orders, Q2 GDP estimate, and the Chicago PMI. If these figures come in negative it will reinforce the recession worries. It's worth noting that these will probably take a back seat to what's happening in Europe.
- Monday, September 26 -
New Home Sales (August)
- Tuesday, September 27 -
Consumer Confidence (September)
- Wednesday, September 28 -
Durable (goods) orders (August)
- Thursday, September 29 -
Weekly Initial Jobless Claims
Q2 GDP estimate
Germany's vote on the EFSF
- Friday, September 30 -
Chicago PMI for September
- End of the third quarter -
Looking ahead I don't see a lot of changes. Friday is the end of the third quarter. It's possible the market could see some window dressing but I am concerned that investors are likely to sell into strength. In about two weeks the focus is going to change toward corporate earnings as Alcoa (AA) kicks off the Q3 earnings season on October 11th. An outbreak of positive earnings news could be just what this market needs to change the tone of trading. Unfortunately we won't know how earnings season is shaping up for another month. Given the trend of bearish economic data we could be facing negative corporate earnings numbers and guidance.
If you believe that stocks will hold their August lows and bounce then this is a good spot to buy some calls on the major indices. You might want to consider calls on the DIA, the SPY, or the IWM but I would use a tight stop under the August low or last week's low depending on which ETF you use. Alternatively, if you're expecting a breakdown, then consider short-term put options to capture the move lower. October options still have four weeks left until expiration. Traders also have a third choice and that's a market-neutral strategy like a straddle or a strangle on the major indices. Unfortunately, with volatility this high, buying options for a straddle or strangle could be very expensive but that doesn't mean the strategy can't work.
Overall I am very cautious on stocks. If we do break the August lows then we're looking at a bearish target of 1050 and 1,000 on the S&P 500 and probably 550 on the small cap Russell 2000 index.