The Russell 2000 hit a new six-week low to lead the big cap averages lower.

Market Statistics

The Russell led the big caps lower once again despite an attempt by the Dow, Nasdaq and S&P to break into positive territory mid-morning. The effort was quickly reversed and the steady selling resumed. This is not a market crash. Selling has been steady with no sharp declines or sudden spikes in volatility. This has been orderly profit taking after the big cap indexes set new highs at the same time Alibaba was surging to $99 on Friday. All have rolled over with BABA now trading at $87 and a -12% decline from its highs.

Multiple market analysts have commented on the extreme bullishness seen in the BABA IPO as the reason for the market drop. Once the IPO is over the bullishness disappeared. One could make the case for the Alibaba hype dragging the market higher and probably a case for a sell the news event following that event.

However, the weakness in the small caps began in July not last Friday. The Russell 2000 and the S&P both set new highs on July 1st but that is where they parted company. The Russell immediately began underperforming the big cap indexes. The S&P went on to set several new highs and the Russell continued to lag. Since Labor Day the Russell has been in a steep decline that has accelerated over the last several days. While BABA may have created a sell the news event in the big caps the Russell already had a head start with a -7.2% decline since the high close at 1,208 on July 3rd.

The small caps typically lead on the way up and on the way down and they are definitely the weakest index in the current market. More than 45% of Russell stocks are in a bear market with more than 20% declines from their recent highs. Until the Russell finds a bottom we can expect the big cap averages to be lethargic at best and at the worst they will be followers.

The Dow declined -0.68%, Nasdaq -0.41%, S&P -0.57% and the Russell was hit the worst at -0.94%.

On the economic front the Richmond Fed Manufacturing Survey headline number rose from 12 to 14 and the highest level since March 2011. New orders rose to 14 and a multi-month high. Backorders declined from 15 to 6 but that was still the second highest level in the last eight months. Employment rose from 11 to 17 and also a multi-month high.

This was a good report although the price for raw materials also rose at a 2.1% rate, which was higher than the 1.39% rate in August.

The Richmond Services Survey was flat with August at 21. The retail portion of the index was also unchanged at 37 but that represents strong expansion underway.

Manufacturing Components

The FHFA Purchase Only Home Price Index rose +4.4% for July compared to +5.1% in June and forecasts for a +5.6% gain. Of the nine divisions only 2 posted declines in prices. Those were the middle Atlantic with a -0.5% decline and -0.3% in the Mountain division. This report was ignored as lagging data.

The calendar for Wednesday has New Home Sales and the NAHB Housing Market Index. With home sales falling in recent months these numbers will be critical for sector direction. Builder stocks are in decline and a gain in new home sales could help to reverse this trend. KB Homes (KBH) has earnings before the open and they are not likely to post the same good news that Lennar (LEN) did last week.

Hopefully the Kansas Fed Manufacturing Survey on Thursday will show similar gains to the Richmond survey. However, the Kansas survey is heavily impacted by auto manufacturing and auto sales have also begun to slow. This puts the Kansas numbers at risk of a decline.

The big number for the week is still the Q2-GDP revision on Friday. The official consensus is still 4.3% but there are estimates close to 5.0% growth. This number could be market negative if it came in too hot because it would suggest the Fed could raise rates sooner. If it came in to low if would be Fed positive but economically negative. Something in the 3.8-4.0% range would be the best outcome.

Next week is payroll week with those numbers key for Janet Yellen and Fed direction.

The U.S. and 5 Arab nations attacked Syrian sites on Monday night with 14 ISIL targets hit and 8 Khorasan targets destroyed. The Khorasan organization was made up of al-Qaeda veterans that were focused on attacking Europe and the U.S. and making bombs to be carried on airplanes that could not be seen by metal detectors. Jordan, Saudi Arabia, the UAE, Qatar and Bahrain were the countries participating in the attack. Iraq, Turkey and European allies were noticeably absent.

The U.S. said the Khorasan group was effectively decapitated because they were not expecting to be attacked and had not dispersed their people and assets. The group was targeted because they were actively seeking passport holders from western nations and their plotting was the reason airline security was increased over the last several months. The U.S. said it had intelligence the group was in the final stages of preparing an attack on the USA.

Within hours of the attacks ISIL posted a video saying the U.S. and its allies were embarking on Gulf War III and not since Vietnam has we witnessed such a potential mess in the making. They specifically threatened Saudi Arabia with retaliation for joining in the attacks.

Russia condemned the attacks saying they violated Syrian sovereignty and would "aggravate the situation even further." The further warned that "those who initiated one-sided military scenarios bear full international legal responsibility for the consequences." The U.S. did inform Syria ahead of the strikes and warned the Assad regime not to engage American aircraft. Syria has a sophisticated air defense system and it would have lost that system if it had been used to attack U.S. aircraft.

The market ignored the attack because it had been heavily discussed over the last several weeks. The fact there were five Arab countries involved in the attack blunted any concerns about the Syrian bombing.

One reason for the market's decline could have been the note from Goldman Sachs. Goldman said ten-year yields could rise to 4% over the next 12 months after the end of QE in late October. Goldman believes the end of QE purchases will spike rates and the economy will force the Fed to begin reducing its $4.45 trillion balance sheet sooner rather than later. Yellen said that after QE ends they would continue reinvesting principle that matured in order to maintain the stimulus that is already in the market. Once the Fed was forced to raise rates they would first halt the reinvestment of that principle and let the portfolio begin to decline. The next step would be to hike rates in a "gradual and predictable manner" according to Yellen.

Goldman said that once QE ended and the reinvestment of principle was halted it would turn into "quantitative tightening" and they believe this will occur sooner rather than later. "The impact will begin as soon as QE ends and reinvesting coupons alone will not be enough to offset the roll down of stock" They expect the Fed to begin tightening between June and September of 2015, if not sooner, and the ten-year yield could rise to 4% within 12 months.

Apple shares rallied $1.58 in a bad market after headlines broke that China was about ready to approve the license on the iPhone 6. That had not been expected until December. Opening up China to iPhone 6 sales would be a big boost for Apple sales.

On the negative side the new IOS 8 operating system is not functioning correctly. The new OS is causing apps to crash about 3.3% of the time or 67% more than the prior version. Facebook, DropBox and other heavily used apps are crashing repeatedly as a result of the new OS. The problem has caused DropBox to release a software fix that works around the errors in IOS 8 that are causing the crashes. Older phones are having the most problems. The new IOS includes more than 4,000 new functions and changes and developers are racing to adapt to the changes. According to Apple 46% of Apple devices connected to the App Store are now running IOS 8. Another big complaint is the massive amount of storage required for the new OS. Many users are being forced to delete pictures, videos and other apps from their phones in order to have enough memory to run IOS 8. Apparently users are fighting through the problems because Apple said it sold more than 10 million new phones over the weekend.

I was really hoping for a decline in Apple shares to something in the mid $90s but it does not look like it is going to happen.

Facebook (FB) announced a new ad program for mobile users in order to better compete with Google. The new platform, called Atlas, will be revealed next week. This is a new re-engineered version of the Atlas Advertiser Suite they purchased from Microsoft in 2013. The platform will allow marketers to know what ads Facebook users have seen and interacted with on third party websites. Google reported ad revenue in Q2 of $14.36 billion compared to Facebook's $2.68 billion. Shares of Facebook rallied +$1.50 on the news.

Alibaba (BABA) may have had a successful IPO but the success ended at the close on Friday. Shares are now down 12% from its highs and -5.6% from Friday's close. There appears to be heavy institutional dislike for BABA after the company management hand picked the companies that would get BABA shares at the IPO price. The majority of companies that received shares got only 10% of what they asked for. The vast majority of companies asking for shares got none. Reportedly 25 companies received 50% or more of their requested allocations. This means the stock ownership is very narrow and in theory that should have led to a lot of demand from everyone that did not get an allocation. However, the process soured those that did not get any or very little and shares are being offered for sale but demand is weak. Volume today was 38 million shares and most of that volume was negative with the stock losing -$2.72 for the day to close at $87.

Jack Ma and his close associates may have tried to be too smart about the allocation process and it is coming back to haunt the share price.

The S&P is closing in on the 1980 support level and that is important short term support. This is the level that held the drop on August 15th. While this is being called crucial support it is not. It is only crucial for the very short term. Critical support is more in the 1950 range and the 100-day average or long term uptrend support in the 1930 range.

At this point we should see at least a temporary bounce from the 1980 level because the selling has been slow and steady and not fast and furious. The fast drops are the ones that blow through support and keep going. Steady selling tends to pause at interim support levels and dip buyers on the sidelines interpret those pauses as bottoms. Sometimes that is self fulfilling if enough buyers take the bait. Sometimes the bounces from those support levels just provide a higher entry point for sellers.

We don't know why the market is selling off this week. We only know that it is overdue and the week after option expiration in September is normally down. This is a portfolio restructuring week ahead of the Q3 earnings cycle.

There was a sharp downdraft right at the close and one commentator called it a potential flush. Sorry, a -5 point drop in the S&P is not a flush. We are not yet in flush mode. As long as the selling remains steady we are in distribution mode. When the drop accelerates into panic mode that is when we can start looking for a flush that signals capitulation. We are not there yet and we may not get there if 1980 pauses long enough for dip buyers to wake up from their nap and get back into the market.

Support in round numbers is 1980, 1950, 1930 with the 50-day average at 1976. I always laugh when someone says support is 1951.62 or something similar. Markets rarely stop on a penny, nickel, dime or quarter. They do stop on ranges and sometimes on round numbers like 1980. Don't be too concerned about the small increments and focus on the bigger picture.

The Dow dropped -50 points in the last 10 minutes of trading to close at the lows of the day at 17,058 and a loss of -117 points. This is the first back to back triple digit loss since June. It is also about -300 points off the high at 17,350 that was set on Friday. That is a pretty straight decline on moderate volume of 6.2 billion shares. This suggests the Dow is rapidly moving from overbought to oversold.

It has also reached the prior congestion range from 16,950 to 17,050. This should be decent support. The last decline in the 12th dipped to just below 16,950 and rebounded. Round number support at 17,000 was a price magnet for late August and early September and will likely be a magnet again.

Back to back triple digit declines sounds ominous but the Dow has only been declining for two days. Get a grip! Two days is not a trend. A two day dip is a blip in the long term trend. If the index moves below 16,950 and the 50-day average at 16,937 then we can start to worry.

The Nasdaq sell off has slowed. After two days of drops from 4,610 to a low of 4,513 the minor -19 point decline today was tame. You can see in the losers list below that there were very few big losses. The Nasdaq is closing in on the 4,500 level and it dipped to low of 4,499.87 on the 15th before rebounding to retest the September 3rd high of 4,610. What goes up fast sometimes comes down fast. Now that it is back at the starting point the number of sellers appears to be dwindling. There were numerous tech stocks that bucked the trend today and posted decent gains.

With the 50-day average at 4,489 and round number support at 4,500 it should take some concentrated selling to push the Nasdaq lower. It would have to be heavier than what we saw today. Anything is always possible but unless we are headed into correction territory the Nasdaq may be near a bottom.

The Russell is closing in on 1115 and support from early August. At the rate it is falling we could see an overshoot. There were two intraday dips to 1108 in August but both produce immediate rebounds. Let's hope that trend continues. The 1087 level is a 10% correction for the Russell. The 50-day is solidly under the 200-day for a death cross but of the last 11 times that has happened only 2 of them led to losses over the next 12 months. The average gain over the next 12 months was 11%.

I believe the selling may be drawing to a close. That does not mean there is an instant rebound in our future and we could trade lower for the rest of the week but I think the majority of the decline is over UNLESS we are headed for correction territory. Every three day decline in the last year has been bought even if it was just an oversold short squeeze. I would tighten your stops on any bearish plays because you know there is a short squeeze lurking in our future.

Enter passively, exit aggressively!

Jim Brown

Send Jim an email

Click the advertisement below for a free trial to the Ultimate Investor newsletter.