Traders that took an early day and left their screens before 3 p.m. Eastern yesterday were unpleasantly (or pleasantly depending on their positions) surprised when they looked at the closing levels. What was a 15-handle range in the S&P 500 for most of the day turned into a 20-plus point nosedive in the final 60 minutes that ultimately closed the so-called “open gap” from the morning.
Technically speaking, after falling out of the bear flag last week, the index is again sitting inside of it. A simple but valuable rule is that once a major pattern such as this one becomes obvious on everybody’s screens and then gets hyped by the media, it either won’t work at all or will take a slightly alternate route (read: more choppiness) to arrive at its ultimate price target.
So far, the bear flags on the S&P 500, Nasdaq and Russell 2000 seem to have chosen the latter as their calling and are whipping traders around. Lest we forget, however, bear markets are made up of sharp rallies such as what we saw yesterday morning, as short sellers get squeezed and are forced to cover their bets by clued-in market participants sniffing out when too many are leaning to the short side.
The technology sector underperformed yesterday as large-cap technology stocks like Apple (NASDAQ:AAPL) and Amazon.com (NASDAQ:AMZN) recorded intraday reversals that led to ugly daily bars on their respective charts.
The tech-heavy Nasdaq continues to struggle with its 50-day simple moving average as resistance, and yesterday again failed to overcome it on a closing basis.
The case for lower equity prices ahead has been laid out. As I always try to see both angles, however, let me point out a couple of things that may make the bears have to fight a little harder for profits:
1. The end of the third quarter is just three trading days away, and besides adding some volatility to the markets, there is also a tendency for stocks to trend somewhat higher during this stretch due to window dressing by funds.
2. Greed, or fear of missing a rally in equities on the part of institutional investors, is what bears should really fear. Yesterday was a classic case of this, as the mere chatter of a European bailout bazooka led investors to scramble for inventory. This could continue for some time as European politicians try to prop up the tape as long as possible.
3. The Russell 2000 small-cap index is starting to show signs of divergence between price and its Relative Strength Index (RSI) indicator.
On the chart below, note that the lower low in price in late September was not confirmed by a lower low in the RSI indicator. In fact, the RSI thus far recorded a higher low. Divergences such as this one are powerful indicators of an impending medium-term trend change and should not go unnoticed.
My broader stance remains the same as yesterday morning: Stocks look to have further to fall. The more important question is that of timing. Will the S&P 500 start dipping toward the 1,040 level soon, or will a European bailout or Greek default rally come first? The coming days will be telling.