New market thoughts from Raymond James’ Jeff Saut: “The Problem with Breadth” 08/18/17

“More than 40% of energy stocks in the S&P 500 hit a 52-week low on Tuesday. When that many sunk to a low in the past, the sector bottomed within a few days most of the time. Another 2-3 days of heavy selling would likely set up a high-probability bounce.”
…SentimenTrader (8/16/17)
So what’s the deal with Thursdays?! Exactly one week after the North Korea nuclear noise reminded us that sometimes the market goes down, stocks broke once again yesterday to hit their lowest point since early July. The S&P 500’s 1.54% decline, just like last Thursday’s dip, felt like a mini-crash compared to the volatility we’ve grown used to this past year, yet keep in mind this great run has also meant we’re probably a little overdue for something on the downside. This action is not unexpected, either, considering we wrote last week that we would not be buying the first dip during the anticipated patch of weakness, a feeling that strengthened once the S&P 500 appeared to stall out by the middle of this week. Market breadth has just not been as strong as it had been the previous few months, and the wilting under the surface finally looks to be catching up to the major averages.
The primary culprit behind the poor breadth is once again Energy. Some names in the space are at or below the early 2016 lows despite the price of oil being about $20 higher, and very few companies have been spared the carnage. Out of the 31 Energy companies in the S&P 500, only three closed yesterday above their 50-day moving average; 15 hit new 52-week lows; and only two finished higher on the day. The sector has consequently dragged down breadth lately, but the selling yesterday was noticeably broad-based, with all sectors of the S&P 500 dropping at least 0.71%. Everyone will, of course, want to try to ascribe a reason for the sell-off, but it may be the up-move from the last year finally just ran out of a steam. It’s now been 286 days, by my count, since the S&P 500 corrected more than 3% on a closing basis, the second longest streak in history after the 1994-1995 period. Hence, a possible end to the prolonged period of NO downside volatility should not be too shocking or concerning, since runs like these are very rare. On the other hand, it also seems unlikely we’ll go from the market having trouble falling even 3% to a major correction, so, to be clear, we’re not advising abandoning all your stock positions quite yet. There’s still plenty of support underneath current levels, and we haven’t really seen major red flags in the economic reports or earnings to make us think conditions are deteriorating.
Speaking to earnings, quite a few stocks were punished during earnings season despite actually beating their estimates. As Bespoke Investment Group noted back last Friday, with nearly 2,500 companies having reported:
…[after a stock’s] initial earnings reaction day passes, investors have been hitting the “Sell” button, regardless of whether the company beat or missed. While stocks that have beaten EPS have averaged a small gain on their earnings reaction days, they’re down an average of 2.63% since then. That’s actually worse than the average decline of 2.02% that stocks that have missed EPS estimates have seen since their earnings reaction days.
It appears, then, that maybe expectations were largely priced in and investors have been “selling the news” after it breaks. If that’s true, it would support just a temporary breather as profits are taken and the next wave of investors eyes lower prices at which they can buy.
We are now, technically, in a pattern of lower highs and lows on a short-term basis, so the bulls have ceded some control, but this morning the futures are flat, so we’ll see if support around 2430 can hold today. That 2430 level is one-standard deviation below the 50-day moving average, which has a history of enticing buyers, and there’s also a probable support line around that point to add to the attractiveness. Aggressive types may want to take a chance on any bounce today, but we’re still being patient here. Moreover, should the market start to struggle once again today, remember our mantra “Never on a Friday,” meaning significant lows are rarely made on Fridays as investors brood over the losses over the weekend and come in Monday ready to sell. The level around 2400 would actually be a higher conviction buy point, anyway, and the 100-day moving average sits around 2415, another possible target on the downside. So, we remain cautious and advise most investors do the same. There still really haven’t been signs of the major washout in breadth that often accompanies major lows, but we are getting close. Weakness today and into early next week would likely set us up for a better buy point at some point next week. The situation remains fluid!

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