What’s Next?

Posted On November 16, 2015 11:50 am

The market internals were already deteriorating and now an external terror attack will make matters worse.

Is this recent sell-off the start of a steeper decline? Or does it represent a buying opportunity. The answer depends on what you are buying and your time frame. Let’s chart out where we may be headed to avoid the pitfalls and identify the opportunities.

After staging a very strong rebound in October the stock market has been in retreat in November. The S&P 500 SPDR (SPY) has posted three consecutive down days and has lost some 4.2% during the first two weeks of this month. This was prior to the Paris attacks and as of this writing on Sunday night the SPY is indicating a gap lower towards the $200 level.

The recent gains were already coming under suspicion and the next few days may determine whether this represents a buying opportunity or the beginning of a fresh leg down. Let’s take a look at where we have been so we can try figure out where we are going.

Narrow is Fallow

The rally in October which measured a nearly 11% made it the best month it the second best monthly gain in over three years and pushed the most of the major indices back up through resistance levels. Many market watchers remained skeptical as to whether this was a sustainable new leg higher or merely a reflexive bounce following the August/September breakdown.

The bears’ main points of contention are that overall volume has not been robust and the rally has been incredibly narrow led by just a handful of names. There is a saying that the generals can lead but the soldiers must follow or the victory will quickly turn to defeat.

Last month few big cap technology companies put the market on their collective back and surged to new highs. In fact on October 23 Microsoft (MSFT) Google (GOOGL), Apple (AAPL) and Amazon (AMZN) gapped up following their earnings adding a combined $130 billion in market capitalization, an unprecedented amount for just four stocks in single day. Apple went on to gain an additional $100 billion on its own over the next two weeks. Throw in Facebook’s (FB) $40 billion gain over the past two weeks and those five stocks have accounted for nearly 68% of the Nasdaq’s gains from the October lows. Which explains why only the Nasdaq made a new high while the S&P 500 and the small cap Russell 2000 have failed to clear the summertime highs.

This chart shows the SPY failure to make a new high, the dissipating breadth and the MACD losing momentum on a bearish crossover. This morning will be testing the 50 day moving average near the $200.50 level.

SPY Chart - 11.15.15

What’s interesting to note is how during September the advance/decline enjoyed a rapid expansion even as the SPY mostly moved sideways consolidating the August decline. This was due to the beaten down names, mostly in the energy/commodity sector enjoying a bounce as oil moved back above $60 and the Fed held off raising rates which caused the dollar to retreat.

We all knew that the $210 level represented a massive overhang of resistance after it spent nearly seven months in that sideways range. But the hope was that many of the beaten down names would climb enough to get people back into the black rather than selling to “get back to even.”

But oil is now back into the $40 level and natural gas is hitting decade lows. Other commodities haven’t fared much better with industrial metals such as copper and iron and agriculture such as corn, wheat and cotton all near five year lows. No relief in sight for the losers and I believe selling will now beget more selling.

Sector by Sector it Gets No Better

This segues to something I mentioned last week in my $20k newsletter and dovetails with the narrow leadership. The $20K portfolio had established a bullish position in Macy’s (M) prior to their earnings report. As we know the company missed top line revenue and gave a very downbeat outlook and the stock tanked 15%. If there was any doubt this might be just a Macy’s problem other retailers from Gap (GPS) to Nordstrom (JWM) also missed the mark badly and suffered steep declines. As I wrote on Thursday,

I just don’t see how an already narrow market can lose the retail sector heading into the holiday season (we’ve already lost energy, REITs and biotech is buckling under political and short selling assault) and the market works higher. I don’t believe it all simply accrues to Amazon (AMZN).  The S&P simply cannot lose another whole, sector’s earnings power, especially as the U.S. is a consumer driven economy, and have the broad indices push to new highs on the back of Facebook.”

And remember we has also seen media come unraveled last month when Disney mentioned slowing growth for cable subscribers and everyone rushed into Netflix. But even that sector after a brief rebound has come back under pressure.

Indeed on Friday we saw selling of the generals as Amazon, Netflix and Facebook each lost over 3% on the day.  As mentioned above the laggards had already turned back lower and now investors are being forced to sell what they can to raise capital.

The internals were already fragile, now with the terror attack in Paris I expect the travel and leisure sector, which had been very promising, will come under pressure.

They say a narrow market is a fallow market and I’m afraid as we lose another important sector heading into the seasonally strong holiday travel period there will be very little fruit to bear.

What Did They Know and When Did They Know It?

It’s been well documented that stock buybacks have been a huge factor in propping up stock prices and help provide the impression of p/e growth as companies borrow cheap money and shrink their share count.

What makes me say “hmm” is the fact that insider selling spiked eve as the market recovered in October back to the old highs.

Insider Selling - 11.15.15

Did they already have insight into declining fundamentals and are aware that a rise in rates will put an end to the Fed fueled buybacks?

Keeping it in Perspective

The bright side to keep mind is that following nearly major crisis or external shock the market has recovered, often quickly. This observation courtesy of the Reformed Broker.

“The market rallied 4.5% on the first day it opened following JFK’s assassination and funeral in the fall of 1963. The Dow Jones actually finished up that year by 17%, despite the deep psychological wounds from the event. Stocks were flat within a week of his brother Bobby Kennedy’s murder in 1968 and they rallied 4.5% during the week following Martin Luther King Jr’s death that same year. Two months after 9/11, the US stock market had regained its losses and had retraced back to where it was on September 10th

Here is an annotated chart showing the mostly steady march higher.

Crisis chart long term - 11.16.15

In the next article I will look at the opportunities that will surely present themselves in the coming weeks. Stay focused and stay patient.

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.