The stock market dropped today presumably on the earnings and outlook of Cisco Systems (CSCO), a tech bellweather. That put the tech sector in a bad light and the NASDAQ as whole under pressure. Tech has been the worst perfomring sector so far today. It may be that bad news is not being ignored by the market anymore, at least not today. Stocks as an index came back about half ways by noon ET, and then faced a batle to get any higher.At 2PM ET the market stands below the base it fell from, a pivotal area that will give some clues as to overall market strength and the appetite for stocks.
One gets a sense that many of the issues we currently have in the economy are going to come back to the forefront and haunt the markets again. The article on several hedge funds getting short, news today that corporate insider selling (the legal kind), is at a high since 2007, and even Jeremy Granthams remarks today that a huge bubble is being created and that equities have gone past what they are worth is carrying some weight on traders and investors minds.
You can view Jeremy Granthams current market commentary and 3d quarter letter on his global investment site GMO: http://www.gmo.com/America. An especially interesting article is titled, ‘Night of The Living Fed’ and can be seen from this page.
So the news environment is being filled with more negative items lately. We could let this affect our overall view, but not to rush into a ‘predictive’ mode lets take a look at the market from a rational objective perspective. If you look at a daily chart of the NASDAQ or S&P 500 (QQQQ or SPY if you cannot get the index qoutes), you will see the market has rallied strongly in a sharp upwards manner. We know that any pullback would be a normal occurance at this point. Things do not just go up (or down), in a straight line.
It has been three weeks since a daily shakeout has not reversed back immediately (10/19), and two weeks before that (10/04). Both of these proved to be short lived shakeouts/pullbacks as the market went on to new highs. Pullbacks are a natural process where traders and investors take some profits and those that fear a bigger drop toss in the towel too. After a pullback the weaker hands are removed from the stock at that level and the door to higher ground is opended.
Of course we can’t forget that even bear markets first start with a pullback too. So the object is to evaluate the quality of pullbacks objectively based on your trading plan rules. Some things to watch for could be:
- Has the trend changed?
- Where is the pullback relative to the trend?
- How far has the market retraced the prior move?
- Were is it relative to the 20 period moving average?
- How has volume changed if at all relative to the rally?
- How long has the pullback gone on?
- Has selling become climactic?
As humans we are always being swept into the emotional highs and lows of trading and investing. Those that have objective rules and know what they will do in certain situations before they happen have the best chance of succeeding. For now the indexes are well above the 20 period moving average, volume has not been heavy, and the trend has not come under question.
Generally when price falls below a base and does not come back right away the shakeout probability goes down and the pullback probability rises. While this makes sense just from the basic definitions of these two terms, price did fall from a short base that will present some resistance as price tries to reenter base price levels. Again, this is best understood from putting yourself in other traders and investors shoes.What are those traders and investors who bought in the base they thinking? They are trapped in a loss and have chance to get out of a bad situation at or near break even if price comes back close to the base.
Some news to underscore the different problem China faces versus the US was out yesterday. A double-digit jump in food costs drove China’s inflation rate to a 25-month high of 4.4 percent in October despite a government clampdown on credit. The price rise, due mostly to a 10.1 percent increase for food, was far above the official target of 3 percent and a sharp jump from September’s 3.6 percent rate.
While other governments like the United States are trying to generate growth from anemic levels, Beijing wants to put a lid on it. China is trying to restore normal economic conditions after their stimulus fueled rebound from the global crisis has overreached on an inflation basis. China actually raised interest rates last month and ordered banks this week to increase reserves in a move to curb lending. “Inflation is limited to food at this point but could spread as money from a flood of bank lending that was part of Beijing’s stimulus moves through their economy”, said William Hess, Managing director of China Analytics, a Beijing research firm.
When one understands this and sees the G20 countries meeting as they are in Korea this week over currency and trade issues it is no wonder that a concensus of action is hard to reach.
Will inflation pressures be the ultimate result here in the US from all the governments stimulus attempts? Evidently not yet, but this of course is the $64,000 question that is being debated in the markets with real money every day. From comments by Fed Chairman Bernanke one would think he is hoping for this, as US inflation is very apparently below where the Fed would like to see it.
Trade with a plan.