Stocks are chopping around between 1,740 and 1,760 as they digest Monday’s plunge. We remain between the 50dma and 200dma as 1,740 provides near-term support.
Our markets quickly forgot about the Emerging Market Crisis as domestic economic concerns took center stage. Monday’s plunge was due to lower than expected manufacturing numbers and the market is nervously awaiting Friday’s employment report. The ADP report this morning was mostly inline with expectations, but it lost a lot of credibility last month when it failed to alert us to the massive miss by the govt’s numbers days later. While many made excuses for the December employment, it is harder to rationalize away two bad months if we miss a second time on Friday.
While it feels counterintuitive, this is the safest time to own stocks in the last three months. Risk is proportional to height and falling 100-points from recent highs lowers our exposure. If we assume this is a routine 10% pullback, anyone who bought the calm and tranquil January highs opened themselves to 10% downside risk. Now that we’ve fallen 5% from those highs, buying these levels exposes us to the remaining 5% downside. 5% is less than 10%, making this a far safer time to buy than when everyone felt comfortable a couple of weeks ago. Take comfort in fear and fear comfort.
Expected Outcome: Modestly bullish – lower end of prolonged trading range.
Traders are taking a wait and see as we trade sideways following Monday’s selloff. Most of the weak and fearful bailed out as we crashed through recent support levels. The remaining owners are nervous, but waiting to see if the situation deteriorates further before hitting the sell button. Prospective buyers are watching the market with interest, but holding back, waiting to see if they can get even better prices. Current owners would rather not sell and prospective buyers are intrigued by these discounts, creating the potential for a nice rebound once these economic fears turn out less bad than feared.
Everything is always less bad than feared……except when it isn’t. Most of the 2013 rally was predicated on a slow but steady economic recovery. If new data suggest a further slowdown, even contraction, anticipate traders repricing the market based on these lower expectations. While giving up a bit of last year’s exuberance brought us to more reasonable levels, markets rarely stop at reasonable and continue to overdone levels.
Expect the chop to continue for the next few days. Resist the temptation to buy strength or sell weakness as the market will likely reverse hours later. This is the time to buy weakness and sell strength. With the market down 5% from recent highs, this is a more interesting buying opportunity than selling one. While we could continue lower, that only gives us even more attractive levels to buy. And above all else, stay calm.
Plan your trade; trade your plan
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.