How to trade this weakness

End of Day Analysis:

The S&P500 steadied itself Wednesday following Tuesday’s crash through 2,40 support. While this price stability ended Tuesday’s emotional wave of selling, the muted rebound was hardly confidence inspiring. The calm didn’t last long because as I write this, overnight futures are down more than half-a-percent. Is this a sign of worse things to come? Or is it simply another routine bounce off the lower end of the trading range?

There wasn’t a clear headline driving Tuesday’s selloff. The best the media could come up with was disappointing earnings. We fear selloffs without a reason if it means the market knows something we don’t. But we ignore ones when the market is simply humiliating nervous and impulsive owners by convincing them to dump their stocks right before the next rebound. Which is this? That’s what we have to figure out.

New and unexpected headlines drive large directional moves. That’s because new information causes traders to change their outlook, and as a result, adjust their portfolios. This wave of buying or selling fuels the big moves. On the other hand, recycled headlines produce fleeting gyrations and quickly reverse because everyone already knows about these problems and they are factored into their outlook. If traders expect something, they don’t adjust their portfolio when those headline pop up again. The million dollar question is if the driving force behind Tuesday’s selloff is truly new and unexpected, or if it is simply recycled headlines we have been talking about for months.

Wednesday’s Fed meeting minutes gave us the strongest hints a rate-hike is just around the corner. Rather than extend Tuesday’s selloff, stocks hardly budged. That’s the clearest indication we have that the next quarter-percent increase is already priced in. We can cross that one off our list.

The next big bogie is third-quarter earnings. Expectations are relatively muted and it is hard to find anyone excited about our economic growth. Many even claim we are in an earnings recession. Given that less than enthused outlook, earnings have a very low bar to clear. While things could certainly could come in worse that this, they have to be be worse than the widely expected sluggish. Since front-line managers continue to see more demand than their current staffing levels can handle, we shouldn’t expect a large falloff in earnings. It will be another lackluster quarter, but the sky is not falling.

Assuming the overnight futures hold these losses into tomorrow morning, expect another wave of reactive selling to hit the market as nervous owners bailout before “things get worse”. But without any real meat to this selloff, this is definitely a better place to be buying than selling. Remember, risk is a function of height. By that measure, this is the least risky place to own stocks since June. Unless earnings over the next few days come in far worse than expected, a bounce off 2,100 support makes for an attractive entry point. When yet another selloff fizzles and bounces, expect underweight money managers to start feeling pressure to chase this market into year-end.

Jani

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