Friday's sharp drop just before the close could be a preview of early January.
In less than a 15 min period just before the close on Friday more than 300,000 contracts of S&P futures were sold. The result was a sharp drop in the major indexes with the S&P closing 18 points below the intraday high.
With the S&P declining in early January in 4 of the last 5 years, the stage is set for a bout of profit taking in the weeks ahead. I am not expecting a correction or even a major decline. The outlook for Q4 earnings and guidance is too good for the market to tank significantly. There are too many investors on the sidelines that have been waiting for a buying opportunity for a long time. While there could be a sharp selloff there will likely be a sharp rebound as well. I expect any selling to be short, sharp and shallow.
The hurdle the market will have to overcome is the potential government shutdown on January 19th. The opposing sides in Washington seem to be growing farther apart every day on what they are willing to accept in order to pass a real government funding bill. With the House still on vacation next week, the fireworks will not begin until somewhere around January 10th. Hopefully, they can reach some agreement and not crash the market as they did with the last government shutdown.
This is a big week for economic reports with the ADP and Nonfarm payrolls. There is also the ISM and ISM Services and the FOMC minutes. As long as these reports are close to expectations they should not be market movers. The market will be moving on its own on portfolio restructuring before the Q4 earnings cycle and the economic numbers will be ignored.
The earnings calendar is lackluster with only Rite Aid and Walgreens as the highlights with Monsanto and Constellation Brands as honorable mentions.
The S&P closed at a two-week low due mostly to the 11 point drop in 10 minutes just before the close. Initial support is 2,650 with secondary support at 2,615. A 5% drop would take it back to 2,550 but I seriously doubt that will happen. A more realistic 3% drop would be to 2,609.
For planning purposes, I am projecting a market decline starting in early May. The Q4 earnings should support the market with guidance related to increased cash flow related to the tax reform. By the time we are half through the Q1 earnings cycle that starts in mid April, the outcome for the year should be known and portfolio managers may be ready to exit positions ahead of the summer doldrums. If the market has not had a significant decline before early May, the summer weakness could be severe. It has been two years since a 10% drop in January 2016. Normally we see one 10% and two 5% per year. There was a 3.1% decline in August. That was the biggest decline since January 2016.
The Dow has rock solid resistance at 24,850 and closed right at initial support of 24,720 on Friday. So many of the Dow components have had enormous gains over the last four months that a drop in the Dow is almost guaranteed. A 3% decline would target 24,100 and a 5% decline around 23,600. I would be surprised if the 24,100 level failed but it is entirely possible.
The Nasdaq is the weakest index. The big cap tech stocks have been lethargic with most of them already in a minor decline. If that increases in January, the Nasdaq could be the index that drags all the other markets lower. The 3% decline target would be around 6,775 and the 5% at 6,635. The Nasdaq has paused numerous times on the way up so it is not as overbought as the Dow. However, the Nasdaq components have been weaker in late December and suggest there could be further weakness in January.
The Russell 2000 was actually the most bullish index last week. The Russell closed at a new high on Thursday by 0.0013 points. There was an attempt to break through the 1,550 resistance on Friday but it was solid and refused to budge. The close was still a two-week low. A 3% decline would be 1,502 and a 5% at roughly 1,470.
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For the last two weeks, resistance was rock solid. That is a clue of what we should expect in January. In order for resistance to be solid there needs to be a large number of sellers at those levels. The Dow was 24,850, which was just below the unofficial target for the year at 25,000. Sellers parked their sell orders at that level and every attempt to move higher was met with a sharp increase in selling volume.
For January, the new tax year will allow investors to close positions they have been holding with fingers crossed hoping to make it to 2018. There is no longer any reason for them not to take profits and restructure their portfolios ahead of the Q4 earnings cycle.
Nobody can predict market movement. We can theorize based on the fundamentals and technicals but there is always that tsunami of unknowns made up of a million investors all acting at once in their own behalf. Nobody can predict what the herd will do but in this instance, we can make a calculated guess.
I expect the market to decline next week. If it does not, I will be thrilled and we will retain a lot of our profitable positions. If it does decline, we will take profits and look to reenter some positions with a more favorable option. Keep some cash in your account in case we get a great buying opportunity. My fear is that we will see a one day wonder where the market drops sharply then immediately rebounds equally as sharp. That would clear all our stop losses, cut our positions in half and leave us hoping for another dip to buy. If you see that happening, it would be ok to jump back into any position that was closed. I would be cautious that the first dip may not be the last dip. With so many investors hoping to buy a dip, there could be a false bottom.
There is always another day to trade if you have money in your account.
Happy New Year to everyone!
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