Buy the dip or sell the weakness?

As everyone already knows, yesterday was a tough day.  Second biggest decline of the year.  A big news story didn’t trigger the slide and the sell-off was fairly methodical without big gaps or dramatic drops.  It was simply a domino effect as one stop-loss triggered the next.  Lacking a major headline, the market simply ran out of buyers and it’s little surprise a technical rally ends in a technical correction.   No doubt the media is trying to identify some culprit, but when dealing with crowds you don’t always need a reason for the herd to make a move.

This morning the markets bounced half a percent in early trade.  Is this the rebound hopeful bulls are praying for, or just a head-fake to suck in bottom pickers?  The question on everyone lips is if this correction is done or not.  Can we buy the dip, or should we sell the weakness?  If we look at the market as a spring, comparing yesterday’s pullback to the recent rally, it’s hard to claim yesterday’s move was overdone and no doubt there is more downside potential.  For the market to stage a recovery, we need fundamental investors to step in and buy these discounted shares.  Are they ready to do that in this environment?  More often than not these more conservative investors will take a wait and see approach after a sharp decline.  I expect prices will need to decline a bit more before value investors see prices as too attractive to pass up.  Of course that doesn’t mean we won’t see a feeble rally to suck in bottom pickers and shakes out late shorts.  And by early afternoon, the indexes are trading in a tight range as both bears and bulls are taking a wait and see approach.

Looking back at the last 12+ months of index price moves, it is hard to find a major down day that was part of a continued uptrend.  Using history as a guide, that indicates a high probability there is more downside left in this move.  But if it really is a technical sell-off, meaning people are selling simply because the price is falling under their stop-loss, this move lower might be more limited.  Technicals can move the market around a few percent here and there, but a major move requires new fundamental data and a change in outlook.  Barring anything new and unexpected, the technical slide will probably peter out around the 1300 level.  I don’t expect this down leg to make a new low unless the market starts getting spooked by its own shadow.  Once the technical selling exhausts itself, we’ll reverse higher.

As for what comes next, we’ll probably trade sideways for the remainder of the summer and won’t resume the uptrend until all the senior institutional traders are back from their summer vacation.  By that time there will be a little more clarity regarding Europe, the election, and economy.   As long as all these things hold together, we should see a year-end rally.  While not the same size as last year’s rally, it will still be very tradable.

It appears FB found a bottom and is rebounding from its grossly oversold levels.  Chances are several dollars of upside remain, but I expect it will run into significant resistance at the $38  IPO price.  No doubt a lot of people dyeing to get out at breakeven and given the gigantic number of IPO buyers, this will be a huge wall to breakthrough.  If it breaks above $38, that would be highly bullish, but realistically I expect it will turn back after running into insurmountable resistance at $38, at least over the near term.  If anyone is swing trading this move, plan on taking profits before it reaches $38.  You can always get back in if it stages a breakout above $38.

Stay safe