The very oversold market rebounded at the open with the Dow up +441 points. Unfortunately, it did not hold with a -650 point decline into the close. This was a very bearish signal.
The markets were very oversold on at the close on Monday despite the +500 point rebound off the lows. S&P futures rallied overnight by nearly 50 points and a monster short squeeze was born. Despite the +441 Dow gain at the high the internals were weak. Volume was only mediocre and advancers were only about 3:1 over decliners. Given the oversold conditions, the short squeeze was very thin and lacked any follow through. Sellers appeared exhausted and the only buyers were the shorts.
Fast forward to Tuesday afternoon and sellers returned in volume. The market-on-close orders were 95% to the sell side with $3.5 billion in stock for sale. Once the indexes rolled over the selling accelerated. Shorts knocked out at the open came back into the market along with a lot of institutional selling.
Two factors stood out to me. The S&P never got back to the intraday highs from Monday at 1,954. The high today was only 1,948. That is a warning sign. The second was the low at 1,867.08. Monday's low was 1,867.01. As much as I would like it to be, that is not a double bottom. Most double bottoms are formed over weeks or months, not in back-to-back trading days. It can happen but I would not count on it.
What this tells me is that the global economic worries and the currency crisis in the emerging markets is not yet factored into the market. Early Tuesday I thought maybe China was now old news since the Shanghai market closed down -7.63% and under the psychologically important 3,000 level. Our market still rallied at the open and it appeared to ignore China.
After the market close in Shanghai, China cut interest rates for the fifth time in nine months and the reserve rate for the third time. They did it after the close and in the middle of the week. Normally those moves are done on Sunday night before the market opens. This suggests they were trying to trap the shorts and produce a monster short squeeze on Wednesday. China promised to support the market but their actual support did not work. This post close announcement "should" push the market higher on Wednesday. It is possible this announcement erased the negativity over the Shanghai market decline for U.S. investors.
The Dow closed -650 points off its highs. You have to go back to the financial crisis and October 2008 for a reversal that bad.
The afternoon selloff also coincided with a Bloomberg article released at 1:56 ET about Citigroup sticking with their call for a rate hike in September. The bank's economists, led by William Lee, interpreted the FOMC minutes differently than other analysts. Citi said the increased concerns by policy makers over financial stability "cemented the case for a rate hike in September."
Other banks had pushed their forecasts for a rate hike well into the future after China's meltdown, emerging market currency crisis and the U.S. market correction. Barclays said on Monday they had pushed their forecast out until March. The Fed funds futures had been projecting between 55% and 65% chance for a hike in September and they dipped below a 26% chance late last week. Citi pointed to the appearance by Fed vice Chair Stanley Fischer at the Jackson Hole economic policy symposium as the wild card in their forecast. If Fischer expresses further concerns about declining inflation, Citi believes that would be a major change in the Fed stance. Yellen will not be attending the Fed conference. There are whispers that Fischer is being groomed to take over Yellen's job in the near future. He is more hawkish than Yellen. Whether the news from Citi had any impact on the market is unknown.
Later in the day, Mohamed El-Erian said volatility in global financial markets is worrisome and will hamper the Fed's ability to raise rates in September. He said the Fed missed its chance to hike rates a few weeks ago when the economic signals were stronger, the financial markets were in relatively good shape and the international economy was neutral. The second two factors "have turned violently against the Fed, so I don't think the Fed will take the risk of hiking in this environment."
Bridgewater's Ray Dalio said the next Fed move could be further easing with another period of QE. Dalio said the risks of deflationary contraction are increasing relative to the risks for inflationary expansion. Dalio said the banks have few tools left to combat another deflationary cycle and the risks are weighted to the downside. Three rounds of QE plus Operation Twist added $3.7 trillion to the Fed's balance sheet and Dalio believes they are not done regardless of how badly they want to raise rates. He believes the Fed must keep rates low to keep government borrowing costs low on the $8 trillion in debt the government has added since the financial crisis to bring the total debt to nearly $19 trillion.
While the analysts in the U.S. are blaming China for the market rout, the PBOC is blaming the Fed. Yao Yudong, head of the PBOC Research Institute of Finance, said the expected Fed rate hike was responsible for the wild market swings. PBOC analysts are worried that the Fed rate hike could accelerate the plunge in U.S. stocks and trigger a sell-off of assets worldwide and even a new global credit crisis.
Regardless of who, if anyone, is to blame for the current global sell off it is clear that the global economic worries are not yet factored into the markets. Sixteen of the top 30 global markets have already declined into bear territory with declines of more than 20%.
The Emerging Market ETF (EEM) is at post crisis lows despite a minor gain today. The Chinese yuan is still declining and pushing other emerging market currencies lower.
There was a flurry of economic reports today but none of them were market moving. The Case Shiller Home Price Indexes showed prices were up +5% in June over June 2014. No surprise there. The FHFA Purchase Only House Price Index showed a gain of +5.6% over the same period.
New home sales for July rebounded from the June dip to 507,000. That was up from 481,000 in June but down from 521,000 in May. Sales rose in the Northeast, South and West but declined -6.9% in the Midwest. There is a 5.2-month supply of homes on the market. The average home price rose from $279,700 to $288,300.
There was some bad news in the manufacturing sector. The Richmond Fed Manufacturing Survey for August declined from 12.6 to zero. The new orders component fell from 17.4 to 1.0 and backorders declined from 9.7 to -15.1. This follows a decline in the NY Empire Manufacturing Survey last week from 3.9 to -14.9. It is hard to see how the Fed can raise rates when the regional surveys are collapsing. The separate services Survey declined from 32 to 30.
Consumer Confidence for August rose from 91.0 to 101.5 and well over expectations for 93.3. This was the highest level since January. Both internal components posted solid gains. The present conditions component rose from 104.0 to 115.1 and the expectations component rose from 82.3 to 92.5.
The headline numbers did not carry over into the buying patterns of participants. Those respondents planning on buying a car declined from 11.8% to 10.6%, homebuyers declined from 5.9% to 4.1% and appliance buyers fell from 52.1% to 48.9%.
More than 21.9% of respondents claimed jobs were plentiful. However, an equal number of 21.9% said jobs were hard to find but that fell -6.5% from the prior month.
The big report for the week remains the GDP for Q2 on Thursday. Since last week, the expectations have risen from 3.0% growth to 3.2%. I remain in the more bearish camp and expect a number under 3%.
The Kansas Fed Manufacturing Survey will round out the week and hopefully it will improve from the -7.0 reading from July. The Kansas survey is heavily influenced by the automobile manufacturers. Over the summer, automakers cancelled the normal vacation shutdowns and worked extra shifts to accommodate the high demand for vehicles. This suggests the Kansas survey could reflect these positive conditions.
Earnings on tap for tomorrow include Abercrombie & Fitch (ANF) and Avago Technologies (AVGO). Retailers Chicos Fashions (CHS) and Guess (GES) will also report.
Earnings out this morning were highlighted by Best Buy (BBY). The company reported earnings of 49 cents compared to estimates for 34 cents. Revenue of $8.53 billion beat estimates for $8.29 billion. This marked the fifth consecutive quarter of earnings increases. Not bad for a company almost given up for dead a couple years ago.
Same store sales rose +3.8% due to sales in major appliances, large-screen televisions, mobile phones and health and fitness devices. Analysts were only expecting a +1.3% increase. These sales caught everyone off guard since sales in the industry for electronic devices have declined -1.9% in Q2. Computing and mobile phones accounted for 47% of sales, consumer electronics 32%, appliances 10% and entertainment products 6%.
Best Buy said sales would grow in the low single digits in the current quarter. Gross margins also increased from 23.4% to 24.6%. Online sales increased +17%.
The company also said demand was so strong it was expanding the Apple Watch offering from 350 stores to 1,050 stores in time for the holidays. The company said sales were off to a strong start since they began on August 7th. By September 4th, they will have watches in 900 stores with expansion into all 1,050 big box stores by the end of September. They are also expanding the Apple store-within-a-store sections at 740 stores. There will be new fixtures and more display tables for iPhones, iPads, Mac computers and the Apple Watch.
They are also increasing the number of Microsoft, Samsung and Sony store-within-a-store sections with new fixtures and more products. Apparently Best Buy has found the right combination of products, services and presentation to compete favorably with Walmart and Amazon. Shares rose +3.68 in a bad market.
Toll Brothers (TOL) reported earnings of 42 cents compared to estimates for 50 cents. Revenue of $1.03 billion also missed estimates for $1.05 billion. The homebuilder said lower realized prices and slower sales impacted earnings. They blamed higher mortgage rates for a slowdown in orders 9-12 months ago. Costs also rose as it opened new communities. Their average sales price declined from $732,000 to $724,000. Deliveries declined -2% to 1,419 homes. Shares declined -8% on the news.
Shoe retailer DSW Inc (DSW) reported earnings of 42 cents, which matched analyst estimates. Revenue of $627.2 million missed estimates for $635 million. The company projected full year earnings of $1.80-$1.90. Sales rose +1.8% compared to estimates for +3.8%. The company said it was trying to improve margins by reducing clearance events. Shares declined -11% on the news.
Crude prices rose 85 cents in the regular session but remain right at $39 tonight. The bounce was short covering ahead of Wednesday's EIA inventory report. Crude has risen on 10 of the last 12 Tuesdays ahead of the report. Analysts are united in the outlook for lower lows and suggest shorting any bounce in WTI.
Crude prices dipped to a 6.5-year low at $37.75 on Monday during the market crash.
Where do I start? What a week and it is only Tuesday! The Dow is down -1,811 points in just the last seven days. That is a whopping -10.4% decline and it looks like we are going lower. The S&P futures are down -16 points at 8:PM.
The S&P is in crash mode with 66% of the stocks, probably more now, down over 10%. Of those 31% are in a bear market with declines of more than 20% as of Friday's close. Given the last two days of trading that is probably significantly higher today.
I thought we had a good chance of a capitulation event on Monday. Volume was nearly double an average day. 52-week lows were 30:1 over 52-week highs. Decliners were 10:1 over advancers and declining volume was 13:1 over advancing volume. Those are all typical statistics for a capitulation day where all the weak holders were flushed and all the stop losses were erased.
I expected a short squeeze on Tuesday. Typically when the markets are down more than 3% over two days there is an oversold rally the next several days. We got the squeeze but it was lackluster with only mediocre volume in the morning and advancers only about 3:1 over decliners.
I looked at several hundred individual stock charts tonight and the vast majority were ugly. Most did not rebound back to their intraday highs from Monday and most closed well into negative territory.
For weeks I have been showing the chart of the Bullish Percent Index on the S&P-500 with the percentage of stocks with a bullish Point and Figure chart holding at about 53%. The dam has broken. That percentage has fallen to only 22.4% over the last four days. That is easily the most bearish chart in my wrap tonight. The last time we were at this level was October 2011.
The percentage of S&P stocks trading under their 200-day average has also fallen off a cliff from 65% to 17.6%.
The percentage under the shorter-term 50-day average fell to only 4.6%. That is getting awfully close to the 0.4% low from October 2011.
Those three charts show us where we have been and where we are now. They do not show where we are going. However, the bearishness has hit so hard and so completely that it easily suggests a counter trend move is due soon.
Markets rarely become so over balanced. They tend to remain in standard norms whether they are moving up or down. The severity of the decline is so extreme that we should expect a serious rebound soon.
At this point if I could run Aladdin's magic lamp and get a free wish I would ask for a continued drop to 1,820 and the October 2014 intraday low. With sentiment already so bearish, another 47-point decline would not be the end of the world. What that would do is free all the closeted bulls to buy the dip, confident that the bottom had arrived. Unfortunately, I do not have a magic lamp.
However, in the time it took me to type the last 15 paragraphs and copy the charts the S&P futures have rebounded from -16 to +3. Something, somewhere has reversed sentiment in a big way. Whether it will hold until morning is anybody's guess.
There is no material support from today's close at 1,867 to that 1,820 low from October. If we do open lower on Wednesday, there is nothing to stop a continued decline.
Resistance is now 1,950-1,955 and roughly the intraday high from Monday.
The Dow touched 15,370 as the intraday low on Monday. That is just above the 15,340 low from February 2014. A full 18 months of gains were wiped out in a little more than two weeks. To say the Dow was oversold would be an understatement.
Ten Dow stocks are already in a bear market. Those are:
On the positive side this should be very strong support assuming China does not meltdown again. They say bull market corrections are short, sharp and scary. I would say this one definitely qualifies.
If we do move lower on Wednesday I would look for a retest of those Monday lows.
The Nasdaq Composite was the best-behaved index with a decline of only 19 points but that does not tell the entire story. The intraday high was 4,689 and the close at 4,508. That is a -181 point decline from the highs. Under normal circumstances, the Nasdaq does not move 181 points in a month, much less in one day.
The big cap favorites sprinted out of the gate at the open with Netflix and Apple posting big gains on multiple upgrades. Netflix closed with a +4.64 gain but that was -$7 off its highs. Apple closed with a fractional gain and -$8 off its highs. There were buyers for the tech stocks but they were covering shorts rather than buying for an investment. Once that short covering faded, it was back to the lows again.
The Nasdaq has not declined as much relative to the October lows at 4,130. We would have to fall another 370 points to test those same lows the other indexes are already testing. This is because the Nasdaq big caps have supported the market for the last six months.
There is light support around 4,320 and then 4,130. Resistance is the 4,695 level and the intraday high from Monday.
The small caps closed at a lower low at 1,104 and -2 points below the intraday low on Monday. This is a bearish signal that suggests the S&P will not hold its intraday lows. The small caps had been relatively stronger due to their lack of impact from the strong dollar and the Chinese yuan. However, when markets are crashing you sell what you can to raise money, not what you want to sell.
Support would be the 1,050 level from the October lows. Resistance is 1,140.
The Vanguard Total stock market ETF (VTI) tested the October lows at $93.78 on Monday and closed at $97 on Tuesday. This suggests the broader market was not quite as weak on Tuesday. This is an index of 3,814 stocks.
I have no bias for the market on Wednesday. While I typed and prepared the last ten paragraphs and charts the S&P futures went negative again to -7. The volatility is extreme and we could easily go in either direction tomorrow. About the only guarantee is that it will be a quick trip.
The market is very oversold and this kind of volatility is typical of tops and bottoms. What we are seeing is the indecision by both buyers and sellers. It is hard to predict a rebound since the short squeeze today was erased so quickly. The volume is so high it has to be coming from institutions and funds and quite a few appear to be liquidating rather than simply taking profits or restructuring their portfolios.
Remember, August and September are the two worst months of the year for the markets. So far August has exceeded its historical norms. Let us hope that September does not follow suit.
In a bull market correction, we normally have a series of negative days that are eventually punctuated by a "high intensity" low. That would be the drop on Monday. After that low there is normally an oversold bounce that lasts for 2-3 days. We got the bounce but it did not last and that suggests a lower low ahead. After the rebound there is normally a retest of the high intensity low followed by a smaller bounce and sometimes a lower low. These bottoms are not made in a couple days. They normally take several weeks. While everyone is hoping for that big "V" bottom, they rarely occur in that manner. Be prepared for continued volatility in both directions.
If you are not getting the posts I have been making to the Option Investor Facebook page, please like our page so you will receive the posts on specific stock events as they occur.
Enter passively, exit aggressively!
Send Jim an email
If you like the market commentary you have been receiving and you are on a free trial then now is the time to subscribe. Don't wait until you miss a newsletter to decide you want to take the plunge.