Has the Last Shoe Finally Dropped?
It's been a month since I last wrote a newsletter for Lessons from the Pros, so let's get caught up.
This summer has turned out to be one of the most tumultuous for the stock market in recent memory. One thinks of this time of year as a slow time in the market, marked by diminished volume and low volatility. Traditionally, this is when market participants are more interested in relaxing at the beach or traveling to some far-off exotic location rather than worrying about what their stocks are doing. The July/August market swoon probably ruined some of those vacation plans, as it made it hard to focus on anything else.
Things got so bad during the summer that at some point there was speculation that the credit markets would seize up entirely, leaving companies that are dependent on borrowing for their very survival with little or no options. The prospects that this would come to fruition sent stocks reeling.
As the credit situation continued to deteriorate, the clamor for the Federal Reserve to intervene intensified. Finally succumbing to the pressure, the Fed lowered the discount rate by half a percentage point. This action provided – if nothing else – a short-term psychological boost to the market, helping to calm the widespread anxiety. Since then, the major averages have mounted a very nice recovery, and surprisingly, the best performer has been the Nasdaq. (We'll delve into this a little later)
Readers may recall in my last piece, "The Goldilocks Economy Meets the Big Bad Bear", I mentioned that markets act as a discounting mechanism. This premise would then raise the question of whether or not the recent decline in U.S. Stocks have served to fully price in the worst-case scenario. Obviously, this question still looms large.
My sense is that in the short-term, (short-term being underscored), the market has largely discounted the fallout from the credit crisis. That said, I do not think the major market averages will eclipse their prior highs anytime soon. My reasoning is simple. The Federal Reserve has made it clear with its latest actions, that it is willing and able on a moment's notice to step in and provide liquidity should things begin to worsen. Ostensibly, what this does is provide an artificial floor in the market. In the long-term, though, there are different issues; chief among them is the risk of a recession. I believe this to be a very high probability but will not affect stocks until later this year.
Let's move on and look at the technical side of market, namely, the ER2. We'll first focus our attention on the longer-term daily chart (below). We can clearly see that the 807 level has been a significant stronghold for the bears (sellers). There have been five failed attempts so far, and the fact that so many tries were repelled at this price, adds to the degree of importance. Also worth noting, is the double bottom that was formed in mid-August.
For a look at a shorter time frame, we'll focus on the hourly chart of the ER2 shown below. There are two focal points here: the first is Monday's late-day reversal, which extended into an opening down gap on Tuesday. This gap will serve as resistance on the next rally attempt and will have a very high chance of filling in upcoming days. Secondly, the trend for this time frame is up, with Tuesday's sell-off constituting a less then 50% retracement of the swing move that began on August 28.
The bottom line: In this holiday-shortened week, all eyes and ears will fixate on the Non-farm payroll report due to be released Friday morning (pre-market). If the data is weak, this will be bullish for stocks, as it will provide further evidence of a slowing economy, thus bolstering the argument for a rate cut at the next FOMC meeting. Wednesday's downdraft, notwithstanding recent market action, has been constructive. Money flows (institutional buying) have been picking-up and the Nasdaq, mentioned earlier, has been outperforming rather handsomely. If this leadership persists, this will signal that the market is on the mend.
So until next time, I hope everyone has a profitable week.
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Gabe Velazquez is a professional
trader with 14 years of experience. His focus is intra-day and swing trading the
ER2 (Russell 2000 e-mini) using technical analysis as his primary tool. Gabe has
managed both stocks and futures accounts as well as conducted educational seminars
on technical analysis for the past ten years. He is a frequent guest on Biz radio,
where he shares his market knowledge and utilization of technical indicators.
Gabe also teaches the