Friday, October 11, 2013

Weekly Market Summary

Coming into this week, SPX and the Dow were near the bottom of their long term (read: strong) channels, with a majority of sectors and ex-US indices holding up well and breadth signaling the market was oversold (post).  "Assume they (the channels) hold and these indices move higher."

By Wednesday's close, SPX, NDX, RUT and 7 of 9 SPX sectors were below their lower Bollinger. This is extreme, indicating that investors were selling indiscriminately (post). Moreover, put/call, which has been indicating complacency, jumped to a rare level of panic (first chart). And Vix spiked higher and made a double close below its upper Bollinger within a few days, a reliable bounce pattern in the past (post; second chart). Combined with the touch of the channel bottoms, these were reasons to expect the indices to change direction and move higher (post).

Thursday's action was remarkable. For the first time in 2013, breadth volume was more than 90% positive (post). In the past, this has often been a momentum kick off for the next leg higher in the market. Friday followed through.

The correction in SPX from the September top was 5%. That matches the correction in August and is shy of the 8% drop in June.

So, is that it for the correction? It might be.

Looked at simply, NDX and RUT corrected to their rising 50-dma while the Dow corrected to its 200-dma for the first time in 2013. This was met with vicious buying, arguably the strongest day of the entire year. The combination of put/call, Vix and the breath factors described above argue for higher prices ahead.

Seasonality into the coming week is strong (post). And ex-US markets are supportive, with Germany's DAX closing at an all-time high on Friday (chart).

If this is a failed move, the indices will break their recent lows in the next week or so. A kick-off like this one that fails quickly is clearly bearish. Another debt-ceiling impasse or 3Q results that disappoint remain possible triggers.

Markets are rarely unambiguous. There are three concerns going forward.

First, the Wednesday low was very unusual. Normally, there is a momentum low (arrows on chart below) followed by a price low (vertical lines). The reason is that downward momentum needs to be worked off before price rebounds. That did not happen this time, at least not yet. The lag can be a day or it can be a week (2012 chart here). This suggests a revisit is ahead. In the case of SPX, a 38-50% retrace or a retouch of the 50-dma (1680 area) would be likely but the typical pattern suggest more than that is ahead.

Second, we have recently been comparing the loss in momentum in the large market cap indices to prior periods, most recently 2011 (post). Even after the last two days, SPX and the Dow are at the same level as 5 months ago while investors have gotten more unhedged long. 75% of the equity market cap is represented by SPX vs just 9% for RUT. The weakness of large caps is not a sideshow, it's the main attraction, and the picture is one of faltering momentum (chart). Tom McClellan has a similar post, using breadth as the momentum loss indicator, here.

Third, although there was a spike in fear this week, investors are complacent and long. Despite a 5% drop in SPX, AAII bulls (41%) is nearly unchanged from a month ago (45%). The same is true for Investor Intelligence. Fund managers are at a near record overweight equities (post). According to BAML, speculators are positioned 'stretched long' into NDX to take advantage of the beta-chase into year end (chart). A 4Q rally is widely anticipated; the market is rarely so predictable.

The channels that SPX and the Dow are traveling in are narrowing. The past two days has already put them back into the middle of the channel and a move to the top is just 2% higher for SPX.