Easy Come, Easy Go

End of Day Update:

Again the market bumped it’s head on the 50dma, giving back all of Wednesday’s gains and then some on exceptionally heavy volume. This is the most volatile trade since 2011 and it is doing a fantastic job of shaking off the summer’s complacency. We are a hair above recent lows at 1,925 and within easy striking distance of 1,900 and the 200dma. Given how volatile we are trading, we could easily tag these levels within the first hour of trade on Friday.

While every dip over the last several years presented a great buying opportunity, the lack of a tangible headline driver and huge volatility make this time feel different from the Taper Tantrum, Fiscal Cliff, Greece, and other recent selloffs. But this back-and-forth also feels different from previous runaway selloffs like the 2011 S&P Downgrade correction that collapsed over consecutive days. Given the lack of recent precedent, it is harder to anticipate what comes next.

While the financial press and talking heads blame the generic catch-all “global slowdown” for this selloff, weakness in Europe and a slowing Asia are nothing new. So why is it all of a sudden are recycled headlines causing owners to sell en mass?

First we need to segregate traders by timeframe to identify who is prone to sell this weakness. Since we are less than 5% from all-time highs and virtually every buy-and-hold investor is sitting on huge profits, few of them are hitting the panic button and we shouldn’t expect the average 401k investor to panic. Next come the medium-termed investors who still think the economy is on the rebound and expects prices to be higher over the next couple years. These guys are not likely to sell and are probably looking at this weakness as an opportunity to buy stocks at a discount. The final group is the shorter time-framed swing-traders who try to time each gyration. These are the guys buying and selling each 50-point move. And while they are exceptionally active, they are also the smallest segment of the money in market.

Long- and medium-term investors are unlikely to change their three- and five-year economic outlook based on these ambiguous headlines, so we should expect them to continue holding. Shorter-term investors are reacting to these moves and given recent volatility, the market has already tripped up a large number of them, reducing the number of them left to sell.

While a dip under 1,900 and the 200dma seems highly likely at this point, both bulls and bears should expect a bounce shortly after. The bull is looking for a decisive rebound to new-highs while the bear is expecting the right-shoulder of a head-and-shoulder pattern. Trading is never easy and the answer will only be obvious in hindsight.

Jani