There was a lot of pain in the market on Friday as Amazon shorts were crushed into sawdust.
The Nasdaq rallied early on gains by the big four techs, AMZN, GOOGL, MSFT and INTC. Of those four Amazon was the biggest winner. Anyone short ahead of earnings and expecting the normal Q3 weakness in their report, was in a world of trouble on Friday. Stocks that can gap $130 on an earnings surprise are probably widow makers for your portfolio. I get it that the stock could have fallen $40 to support at $935 on a bad report but the upside risk is too great. The same is true on stocks like Facebook, Nvidia, Broadcom or Alibaba. They are too dangerous to buy/short as an earnings trade even if you have several million dollars in your account. This is a perfect case for options.
The November $1,020 call option was $10 at Thursday's close and $89 at Friday's close. The $950 put was $17 on Thursday and $1 on Friday. Every one of those Amazon shorts are wishing today they had bought that put rather than shorted the stock.
The challenge for us next week is deciding if the gains are going to stick or will the post earnings depression phase appear a week earlier than normal this year. With more than half the S&P already reported the earnings expectations for those stocks has already evaporated. There are still 135 S&P stocks reporting this week so there is some market support but the declines in the 273 that have already reported could offset those still to report. As the cycle progresses, the numbers will favor the depression phase since next week there will be 408 stocks that have already reported and only about 35 companies reporting in that week.
The Nasdaq gapped exactly to resistance at 6,700 and came to a dead stop. "IF" there is going to be a decline, this is where it "should" start. The index is prone to sudden declines when it reaches this uptrend resistance.
The index was in decline ahead of the earnings and that suggests investors were already taking profits from the October bounce. Everyone was leaning bearish and was caught off guard by the short squeeze. This giant candle exactly to resistance rarely continues higher. That is especially true for a new high.
I looked at Nasdaq candles all the way back to 2010. The only candle that even came close was a 100-point spike on Oct 27th 2011. Over the next three days, the index fell -150 points. This type of gap higher is almost always filled, which would be a drop back to 6,560. I am not saying that is going to happen but the chances of a big decline back towards that level are very good.
The Dow is struggling after its 1,685-point sprint from the September 8th lows. The Dow remains very overbought and came very close to ending the day negative on Friday. Resistance at 23,475 has been strong since the first touch on Oct 24th. I would not be surprised if we saw a drop back to 23,000 or lower in the coming weeks. The Dow only has one component reporting earnings next week and that is Thursday after the close so there will be no earnings lift the first four days.
The S&P broke out to a new high but was not as bullish as the Nasdaq, which gained 2.2% compared to 0.8% on the S&P. This index has plenty of converging support in the 2545-2555 range and that should hold on anything but a major market decline.
The A/D line on the S&P struggled last week after closing at a new high the prior Friday. The strength is starting to fade but the Friday gains kept it from closing at the low for the week. This suggests we could see this indicator roll over next week and that will be negative for market sentiment.
The Volatility Index is back under 10 again and flashing its complacency warning. The index closed at a historic low on October 5th at 9.19. Prior to 2017, the last time the VIX broke below 10 was in 2007 just before the market crash. Since the beginning of May, the VIX has been under 10 nearly 60 times and closed at a historic low. The VIX is not a trigger indicator that warns of market crashes but it does tell us when the investors are over confident and a market crash could happen. It is telling us over the last two months that investors are complacent and warning of a potential correction to this condition.
For the last couple months, the FANG stocks have lost their correlation. They were in lock step in July but deviated in Aug/Sep. Last week they all spiked back into lock step. This would be ok if it continues to the upside but we do not want them to be arm in arm if they begin to decline.
The semiconductor sector has been leading the Nasdaq higher and the new high on the $SOX on Friday is also looking very overextended. The chip sector is important and I do not expect a major decline but it could do with a retracement to relieve some of the pressures. Unfortunately, that would lead the Nasdaq lower as well.
Market risk is rising. As each index and sub index makes new highs and becomes even more overbought, the risk increases. Earnings should continue to provide some support this week along with the tax plan announcement and the new Fed chair announcement. However, both of those events also contain risk if the details are not market friendly. I would be cautious about being overly long this week. Keep your stop losses in place and some cash in your account in case we get a buying opportunity.
The trend is our friend until it ends but there is rarely any warning.
Enter passively and exit aggressively!
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