By: Steve Smith
On Friday, I wrote about Why This Decline Won’t Turn into a Sell-Off? It only took until Monday for my thesis to look foolish, if not outright wrong, as stocks suffered their largest daily decline in five-plus months – helping the indices on pace for their worst monthly performance in over a year.
However, during Monday’s last hour, stocks cut their losses nearly in half, and have enjoyed some moderate follow-through higher today.
One of the items I highlighted was that it seemed the SPDR TRUST S&P 500 (SPY) was on the verge of breaching the 50 day moving average, targeting an initial move down to $435. The SPY low on Monday was $430, representing a 5% decline from all-time highs. As I mentioned in Options360’s Monday Outlook, the weekend issue of Barron’s weekend issue stated that “the Stock Market Dropped Because There’s Something Scarier Than Taxes, Tapers, and Contagion; it is the 50 day-moving average.”
One of the trading guideposts is that if everyone sees something, and has an overwhelming consensus, then it’s priced in and won’t work.
Indeed, on Monday afternoon JP Morgan (JPM) issued a report saying the “selloff is primarily driven by technical selling . However, our fundamental thesis remains unchanged, and we see the sell-off as an opportunity to buy the dip. .. Risks are well-flagged and priced in, with stock multiples back at post-pandemic lows.”
However, I don’t think we’re quite out of the woods yet. The 50 dma break – while pointless long-term as far as economic recovery – corporate profits and supply chain issues, do have a short-term impact in stocks’ price action. The market’s increasingly run by algorithms keyed towards momentum. Presently, the upward momentum is broken. To update Friday’s chart, where we saw weight building to pressure a break, we now see the 50 dma, which had been support, will now act as resistance.
My best guess is that we still need to see both a retest of Monday’s low, and a fall back to the $420-$425 level, which would qualify as a 10% correction, before we can resume a healthy and sustainable new leg higher for this bull market.
Regarding the Federal Reserve meeting tomorrow, I’ll go out on a limb and that say no matter what, the FOMC decision or Powell’s comments, will result in bullish action. This may seem contradictory to what I just wrote above; but remember, all trading, especially options, is based on a time frame.
If Wednesday’s initial reaction to the Fed is a sell-off, I’ll be looking to step in and buy the dip for a short-term move back up to Monday’s gap. At that point, I’d become a SPY seller near the $440 level.
Dips can still be bought. However, I think you need to practice patient with time and price; say 5%-10% over the course of two to three weeks rather than 2% to 3% over two to three days