Friday’s rebound was entirely expected, especially in light of the better-than-expected payroll numbers. And a drop in the unemployment rate to 9.1% provided encouragement to traders that perhaps the market had experienced a “selling climax” and would reverse and wipe away all fears.
And when the CBOE Volatility Index (VIX) rebounded to an intraday high of 39.25 and a 13-month closing high at 32, some thought that the worst was over. But with the Dow Industrials and Transports flashing a Dow Theory bear market and the S&P 500 confirming a breakdown at 1223, there is no support for a positive outlook near term. Let’s face it: the U.S. markets have broken down technically — and with gusto. Thursday’s market breadth reached an extreme with down volume registering 87-to-1. To put that number in perspective, a 10-to-1 reading on a day down is considered bearish.
Note the monthly chart of the S&P 500 with its 12-month moving average. Normally, this chart is published at the end of the month, but the damage is so severe and the sell signal at about 1275 so visual that I want our readers to have the benefit of it now — with the caveat that a massive rally prior to the end of the month could negate the results.
The situation in foreign markets is no better. The iShares Emerging Markets (NYSE:EEM) exchange-traded fund graphically illustrates the massive breakdown with very high volume both Thursday and Friday. There is some support at around $38 (not shown) but there’s no reason to expect anything more than a bounce from that level and then a move lower.
Following the close on Friday, Standard & Poor’s downgraded U.S. debt to AA+, and that will no doubt inject another element of uncertainty in both U.S. and world markets. As I am writing this, the European Central Bank announced that it would purchase government bonds of Italy and Spain on a large scale in “the most dramatic escalation of its nearly two-year effort to stem Europe’s unfolding debt crisis,” according to The Wall Street Journal. Rumors abound that the Fed has something “up its sleeve,” but we must deal with what we know, and what we know is that both domestic and foreign market are in sharp declines.
This week could be another volatile one with stocks falling sharply lower. But volatility works both ways and short-sellers could do well as long as they trade smart and enter stop-loss orders with their shorts. The target of this decline appears to be somewhere in the vicinity of last summer’s lows, and so investors should either sell or embark on defensive strategies like put buying or writing options on current positions.
Read Sam Collins’ Trade of the Day: Occidental Petroleum Not Looking Slick
