Sell-off continues

By Jani Ziedins | Intraday Analysis

Jun 04

S&P500 daily @ 2:25 EDT

The markets opened higher, but quickly turned those gains into losses as they reversed lower in the first 20 minutes of trade.  It seems eager speculators were trying to catch a falling knife after Friday’s massive sell-off, but after that temporary support, the markets resumed their slide due to a lack of follow on buying from a wider pool of investors. In fact, some larger money managers most likely used the early strength to sell even more of their positions, causing that quick reversal just 10 minutes after the open.

The one positive through late morning is the selling is fairly orderly and there has not been a mass rush for the exits as we are down a manageable ~0.5%.  But that could easily change this afternoon if the markets fail to find a floor and this weakness triggers even more selling.  It will be interesting to see how many potential sellers are left in the markets after the two-month decline and Friday’s steep sell-off.

The question we are left to ponder, “what is greater, the fear or the reality?”  Has the market underpriced the risks ahead of us, or is it irrationally fearful of what is over the horizon?  The problem in 2008 was the markets grossly under-appreciated the risks associated with the banking sector, leading to a massive crash in Oct 2008 as the world finally woke up to just how dire the situation really was.  Are we in a similar position where Greece, the Euro, and US economic recovery will also catch investors off guard?  Seeing how the media has obsessed over these headline issues for the last two years, it would be hard to make a case these events are still flying under the radar.

But that doesn’t mean the selling will stop since fear and selling begets more fear and selling.  It is a highly contagious disease that spreads quickly with devastating consequences for anyone standing in the way.  Crashes need a trigger to get kicked off and Friday’s jobs report could easily qualify.  But how much fuel, ie weak holders, is left in the markets?  Are there enough to trigger another 20% plunge like we saw last summer?  Anything can happen, but I expect we are closer to the end of this correction.  There is only a 1% cushion remaining from this year’s first quarter rally in the S&P500.  Is this the magic value the market is magnetically drawn toward?  Often the markets target obscene values before finally reversing.  Is 1257 that bogie?

Speaking of which, it is crazy how quickly the markets can unravel the best first quarter in 30 years.  Easy come, easy go.  It is simply another example why the savvy trader always harvests his profits when the sun is still shining.  The markets peak when everyone is most optimistic, so when everyone is bullish, it is time to start trimming positions.

But back to the previous discussion, using the above logic, it seems ~1250 is our line in the sand.  Find support there and it could make for a good swing trade as the market rebounds.  Crash through this level and we could see a cascade of selling push us down to and through 1,200.  But from what I see, there is a lot of fear in the markets right now, meaning we could be close to the end of this move.  But remember, only impulsive traders try to pick the bottom; disciplined traders wait for the follow through day before jumping back in.  Given how far we’ve come, I expect the next follow-through-day has a high probability of being the real thing.  While I don’t expect it will lead to new highs in the indexes, it will make for a good swing trade as we bounce to the upper end of the summer’s trading range, most likely near the 50dma in the mid to upper 1,300 range.

INVN daily @ 2:26 EDT

As for individual stocks, I’ve been neglectful of maintaining my watch list as I am simply waiting for all the shoes to drop and see where leading stocks stand when the market finally finds its footing.  As an example of how hard the leaders can fall, 1/2 of my old watch list is down 20% or more from its 52-week high, with 1/3 down over 30%.  Most scary is INVN and FOSL who are down over 50%.

In the rebound, the best short-term trades will come from the high quality stocks that got smacked down hard due to irrational selling.  Once the broad market pressure lifts, many of these stocks will pop like a cork.  The better longer-term trades will come from the high quality stocks that resisted a sharp sell-off and held up better than most.  But because they were not subject to an irrational sell-off, their near-term upside will be more limited in comparison.

Stay safe

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About the Author

Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.