“The stock market rarely trades exactly how you think it should, but a drop down to around or just under 2685 that is met with strong buying demand would be about the best bottoming sequence I could imagine.”
…Charts of the Week, 11/14/18
As outlined in Wednesday’s Charts of the Week report, I was ok watching the market fall over the last few sessions since that still felt like a normal part of the bottoming process. While V-shaped bottoms do happen, they are rare, and usually it requires the market to do some bouncing around first to prove it’s not about to fall off a cliff for buyers to have the confidence to step back in after a decline. The fact that there were big obvious gaps in the charts sitting there from two weeks ago for many indices and individual stocks only made it more likely that we would have to experience some additional weakness to fill these gaps before we could move on from this corrective phase. We, therefore, thought it would be ideal bottoming action if the S&P 500 filled its gap by trading down to 2685 and then proceeded to push higher, lifting us away from around that support level.
For a while on Wednesday it looked as if that was exactly what was going to occur, as 2685 did end up producing support to take the index back above 2700. I was getting ready to just retire from the markets altogether since it would be hard to top that call going forward, but, alas, we came in yesterday in sell mode and the S&P 500 dropped a little beneath the 2685 level during the morning. The response to that weakness, though, was about as good as we could have hoped for, and the way the sequence played out may have even provided further confirmation that the market continues the bottoming process. During the sharp declines of last month, whenever the market took out the previous day’s lows or other potential support levels, we would very often see acceleration to the downside as the weak buying interest was quickly swallowed up. This time, however, it was the bears that failed to take charge, and the bulls were able to circle the wagons into the close to take the S&P 500 more than 2% off its intraday low.
It was interesting, too, that even as the large cap indices traded sluggishly and threatened to break down further during the morning, the riskier areas of the stock market like small caps, semiconductors, and biotechnology were generally holding up better and staying right around their Wednesday lows. Very often, you can tell where the broad market is going to go based on how the riskiest stocks are trading. If the market was about to drop once more, I figured we would be seeing risk assets leading the way lower, but since that did not appear to be occurring, I held onto the view that stocks were finding buyers and a reversal higher was possible. Conditions remain a bit “nervy,” but overall I still think this a market that at least wants to move higher now.
The question then becomes can stocks actually sustain a rally this time? Ultimately, I want to see the S&P 500 and other indices follow-through on yesterday’s reversal by moving up above where they stalled out earlier this month. For the S&P, this means recapturing 2815, though it does not have to go straight back up to do it. It can still bounce around from day to day, but ideally it will not retrace back down to take out yesterday’s low. If that happens, I’ll take it as a sign that the selling may not yet be done, but if the pattern continues to play out like I’m expecting that should not happen. And if the market really is forming a bottom, then most stocks should have a better environment in front of them and I would prefer to look at the areas that have been beaten down pretty badly during this corrective phase, like Technology, Energy, Biotechnology, and maybe even the Semiconductors (all outperformed yesterday).
Semiconductors are the big question mark due to some high profile misses yesterday after the close (NVDA, AMAT), and that looks to be one of the things dragging down the futures this morning along with Brexit and trade headlines (S&P futures down 15 points as of 6:30 a.m.). That was not what I wanted to see, but again I will now look for signs that early weakness is finding support. It is option expiration day, and as Jeff Saut commented, “Usually stocks rally early on expiry-related buying; the last hour is purely trading roulette.” Next week will bring the Thanksgiving holiday here in the U.S., too, which means volumes could start to dry up heading into next Thursday. I hoped we’d start to see a rally form before then since it can be harder to believe in moves taking place on lower volume, but time is running out. The short-term downtrend has flipped back to positive based on the charts (see chart below), so the bulls have permission to buy, but now we just need to see if they are ready to charge.
