As I write this, investors are enjoying respite from the big wave of selling pressure that battered the market late last week. Like a rogue wave, it seemingly came from nowhere and carried great destructive powers: It capped the worst losing streak for the Russell 2000 since 2011.
There are a number of catalysts in play including banking issues in Portugal, Argentina’s missed debt payment, and ongoing tensions in places like Ukraine, Iraq and Gaza. Offsetting this somewhat was a better-than-expected report on Chinese factory activity as well as the ongoing strength of the Q2 earnings season.
But the kicker has been indications that the Federal Reserve could raise interest rates in the early part of 2015 given the bounce back in the economy, ongoing strength in the jobs market and the newfound confidence by the more hawkish members of the Fed’s Open Market Committee. This is an issue that’s not going away as folks are forced to prepare for the first increase in the cost of money in eight years.
But backing up and looking at the technical indicators, there is evidence that there is more market selloff to come. Here’s a look at three signals:
Percentage of S&P 500 Stocks in Uptrends
Click to Enlarge If you look at the percentage of S&P 500 stocks in uptrend, the percentage has dropped to 74% from a peak of nearly 85% in early July. But we’re still above the low of 65% from April and the 62% low in early February.
Moving further back, the start of the current uptrend phase in late 2012 (amid the scare over the fiscal cliff) featured a low on this measure of 58%. And if we go all the way back to late 2011, amid the fallout over the loss of America’s AAA credit rating, the measure dropped to 22%.
NYSE Hi-Low Index
Click to Enlarge The NYSE Hi-Low Index looks at the relationship between new highs and new lows to measure how overbought or oversold the stock market is.
Deep pullbacks since the current uptrend began in late 2012 have been associated with a drop to around 45 on the index. The late 2011 wipeout was associated with drops below 25. Right now, the index stands around 75 — down from a peak of nearly 94 in late June, but with plenty of room to fall further.
Moreover, when the index is falling through its lower Bollinger Band, as it is now, it often marks the acute phase of a pullback.
Click to Enlarge Smaller, riskier and more economically sensitive stocks have led the way down. You can see this in the way the Russell 2000 is back below its 200-day moving average and is retesting the lows it hit back in early February. The backbone of the market, industrial stocks, is faltering as the Industrials SPDR (XLI) drops to test its 200-day moving average.
But despite this, the overall market as represented by the S&P 500 has barely budged. A test of the 200-day moving average would drop the index to around 1,850 from 1,940 now — a nearly 5% decline. A test of the February lows would see the index trade down to 1,750 — a near 10% drop from here.
How to Play It
Click to Enlarge In response, I’m recommending conservative investors raise some cash while the more aggressive look to actively profit from the pullback that’s developed. Areas of weakness including energy stocks as the Energy SPDR (XLE) drops below its 50-day moving average for the first time since January.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm. As of this writing, he had recommended DUG to his clients.