The S&P 500 fell out of bed Thursday morning when the Philly Manufacturing Index came in below expectations. This conspired with Wednesday’s rate-hike fears and we crashed through 2,040 support. But just when it looked like we were falling into the abyss, we ran out of sellers and rebounded into the close, erasing a big chunk of the morning’s losses.
It was a scary morning for the traders who reactively dumped their stocks before “things get worse”. But for the contrarians in who moved to cash last week, this price-action is exactly what we have been waiting for. As I wrote last week, I was excited about March 10th’s 1.25% pop. That is until the rebound stalled the following day. That’s when I told my subscribers I was taking profits and moving to cash. A sustainable rebound would keep going. When last week’s rebound fizzled, that was our signal to move to the sidelines. But rather than give up on the trade, I knew I was simply early. Breaking support this morning and then rebounding is the sign I was looking for to jump back in.
Even though the headlines and price-action feel scary, these are nothing more than recycled news stories. We’ve been talking about rate-hikes, Chinese slowing, oil weakness, a sluggish recovery, and strong dollar for six-months. Traders that fear these stories sold a long time ago and were replaced by buyers who are comfortable holding these risks. This churn in ownership is how news gets priced in. When there is no one left to sell a headline, it stops mattering. While an inflammation here and there can cause some indigestion, the size of each successive dip gets smaller and smaller. Without anything new to add to the same old story, we can be comfortable knowing dip won’t go much further.
And if we need confirmation, 74% of StockTwits users on the $SPY stream are bearish and AAII bullish sentiment is at 5-year lows. Pretty surprising how bearish the crowd can be when we are less than 5% from all-time highs. Is it reasonable to expect a big chunk of the market to see the next big crash coming from a mile away, or is it more likely that the crowd is getting this one wrong and selling just before we rebound? It’s pretty obvious which side I’m on, but only time will tell for sure.
Thursday’s rebound created an attractive entry point but just like last week, if this bounce fizzles, then we’re still too early and need to move back to the sidelines. If this is the real deal we should rebound decisively Friday. We don’t need positive news story, simply an exhaustion of the selling. People trade their outlook and with so many bears running around we have to be darn close to running out of sellers. No matter what the headlines are, when we run out of sellers we stop going down.
What’s a good trade worth to you? How about avoiding a loss?
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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.