Yesterday, the market tumbled again. The full impact of last Thursday’s jobs losses has spread doubt that the economy is turning. And fear that the upcoming earnings for Q2 will reveal that the recession is far from over pounded all 10n of the S&P 500 (SPX) sectors to a lower finish.
Energy stocks and the financials took hard hits as selling was focused on those stocks that did the best since the March lows. Data from Thomson Reuters indicating that analysts are expecting the S&P 500’s basic materials sector to show a 79% decline in profits and the energy sector to show a drop of 65% focused the selling on those areas.
The apparent difference of opinion between the White House and Congress over an additional stimulus package added a further element of uncertainty. While President Obama said that another stimulus package “isn’t off the table,” Senate Majority Leader Harry Reid said that he doesn’t believe there is any case for another economic stimulus package at this stage.
The day started off lower and gradually got worse with selling accelerating into the close as most indices closed near to or on their lows of the day.
The Dow Jones Industrial Average (DJI) fell 161 points to 8,164, the S&P 500 lost 18 points at 881, and the Nasdaq (NASD) dropped 41 points to close at 1,746.
The NYSE traded 1.1 billion shares, with decliners ahead of advancers by almost 4-to-1. On the Nasdaq decliners were ahead by 3-to-1 on volume of 661 million shares.
August crude oil extended its losses, falling $1.12 to $62.93 a barrel, and the Energy Select Sector SPDR (XLE) fell $1.17 to $44.52. The next support for the XLE is at $41.50 to $43.
August gold gained $4.80, ending at $929.10 an ounce, and the PHLX Gold/Silver Index (XAU) closed at $133.51, down 71 cents.
What the Markets Are Saying
Yesterday’s drive through the neckline support of the Dow, the S&P 500 and the NYSE Composite Index is confirmation that the near-term trend of the market is down and that the head-and-shoulders of those major indices has been penetrated.
Along with that, Nasdaq closed below its June 23 low, thus forming a downward channel with a lower high and lower low since the high of June 11.
Every one of our internal indicators, the Moving Average Convergence/Divergence (MACD), stochastic, Relative Strength Index (RSI) and momentum, flashed sell signals despite being in somewhat oversold territory. And the CBOE Volatility Index (VIX) closed higher for its fourth straight day.
Volume, however, remained low, and this fits the pattern of the vast majority of established head-and-shoulders patterns. Volume is usually low on the days of the break and then builds as sell stops are triggered. And then look for a short-term selling climax to occur with volume taking a sudden spurt — this is the signal that the first phase of the breakdown is over. If you are short, that is the time to cover.
The selling climax is usually followed by a “dead-cat bounce” that often takes prices back up to the old neckline, which now acts as a resistance line. And the bounce may even be accompanied by high volume, which deceives the bulls, luring them into a bull trap.
But patient traders will take their biggest and most rewarding short positions at, or even above, the old neckline since high-volume selling then turns down to their ultimate short-term objective.
On Monday, I provided the following breakdown objectives: “If these breaks occur, the minimum downside targets are: Dow 7,620 and S&P 500 820.”
But please don’t take this scenario as absolute. There is nothing “absolute” when it comes to trading stocks, and we could even see a bounce today that could be shorted. This is just a common pattern for most head-and-shoulders breakdowns.
Be flexible and be careful. Only speculate with the money that you can afford to lose.
Today’s Trading Landscape
Earnings to be reported include: Alcoa (AA), Family Dollar Stores (FDO), Nu Horizons Electronics (NUHC), Pepsi Bottling Group (PBG) and WD-40 Co. (WDFC).
Economic reports due: July 1 Mortgage refinance applications, July 2 U.S. Energy Department oil inventories, May consumer credit (the consensus expects -$7.7 billion).
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Sam Collins is a registered, fee-based portfolio manager who may be contacted at samailc@cox.net. You can also check out an archive of his most recent market outlooks.
