Thursday's big market drop could be reversed on Monday.
I wrote in the Option Investor commentary this weekend that event risk more than likely kept investors from buying the Thursday dip. Once the weekend event risk faded, we could see traders rush back into the market. It is Sunday evening and North Korea did not attack and the S&P futures are up +9.50 as I type this.
In a perfect world that would produce a major short squeeze and the market would recover lost ground and move on to set new highs. Unfortunately, this is not a perfect world by a long shot. We may get the big short squeeze but there is no guarantee that we are going to just shoot up to new highs.
The market crash on Thursday damaged sentiment and pushed the indexes to multi-week lows. While we may rebound, the key will be whether or not portfolio managers utilize the bounce as an opportunity to lighten up their portfolios ahead of September and the possible government shutdown. August and September are already the two weakest months of the year and the risk of a shutdown could make September even worse than usual.
The budget battle and debt ceiling increase both have to be approved by the end of September. When lawmakers come back from their August recess, they only have 12 working days to make that happen and both sides are already promising to block the bills unless certain things are added or deleted from consideration. In 2011 when the government shutdown, the market imploded. While a shutdown may not happen this time, the threat of a shutdown will cause volatility until the bills are passed.
The S&P declined -36 points on Thursday, rebounded 3 points on Friday and the futures are up over 9 on Sunday night. If an opening short squeeze does appear, it would have a long way to go to recover those 36 points. That assumes there are no sellers waiting at resistance around 2,465.
The Thursday decline was ugly but the S&P is only 1.6% from its historic high so in real terms it was just a hiccup.
The Dow fell -204 points and barely remained positive on Friday but Dow futures are up 71 points. The Dow is not even close to strong support at 21,500. The internal rotation has continued with a different set of stocks up every day to keep the index near its highs.
The Nasdaq declined -135 points on Thursday and rebounded 39 on Friday. That was a good day considering the weekend event risk. The Nasdaq futures are up +33 on Sunday evening. The big cap techs were strongly positive as traders rushed to buy the Thursday dip. The idea was to take advantage of the buying opportunity and to heck with North Korean missiles.
The Nasdaq has had five major one-day declines since March. In the past, they were always buying opportunities. Eventually, it will be just the first day of a deeper move and we always need to be aware that the market will not go up forever.
The Russell remains the weakest index. The Russell is down -5.4% from its highs and has broken critical support. Any further decline should target the 1345-1355 range. The small caps are typically the market sentiment indicator and sentiment has broken.
While the market may rebound on Monday, there was serious damage done to the S&P advance/decline line. This was the biggest decline since March and the S&P is only 1.6% below its highs. With the market breadth weakening so badly, I would be surprised to see a strong vertical move higher after Monday's short squeeze is over.
The earnings calendar is shrinking with only 20 S&P companies reporting but we do have the last three Dow companies to report. Home Depot, Wal-Mart and Cisco Systems will provide the volatility for the Dow. I would expect HD and WMT to beat and CSCO to beat but not impress traders. Alibaba will be the most watched report for the week.
The economic calendar will focus on the FOMC minutes and clues about what to expect at the September meeting. Retail sales could disappoint and that could weigh on the market. The Philly Fed Manufacturing survey is a wild card but not likely to move the market.
I would continue to caution about not being overly long until after we get through the September volatility. Late September, early October is typically when markets bottom for the second half of the year. November starts the best six months of the year. Be patient and plan on utilizing a buying opportunity when it appears in the weeks ahead.
Enter passively, exit aggressively!
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