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Expect a Bounce After Friday’s Beating

Internal indicators grossly oversold; likelihood of a bounce high


A disappointing jobs report on Friday resulted in the worst day for stocks this year. And it also resulted in a loss for the year for the Dow industrials, the NYSE Composite and the Russell 2000 indices. The prices of U.S. Treasury issues jumped with the 10-year note yielding 1.467%, a record low.

Friday’s reaction to the bad jobs numbers and their impact on stocks is just a continuation of a nasty trend that began in mid-May with the breakdown of many indices. And that was caused by Europe’s debt problems and a slowdown of growth in China. It is now clear that the global recession has finally slammed the U.S. economy and our stock markets.

On Friday, the Dow Jones Industrial Average lost 275 points, closing at 12,119, the S&P 500 fell 32 at 1,278, and the Nasdaq plummeted 80 points to 2,747. The NYSE traded 989 million shares and the Nasdaq crossed 555 million. Decliners exceeded advancers by over 6-to-1 on the Big Board and over 5-to-1 on the Nasdaq.

SPX Chart
Click to EnlargeTrade of the Day Chart Key

Friday’s massive sell-off produced a break from the bearish flag and a close under the S&P’s 200-day moving average at 1,285. And it tells of a confirmed trend shift to the bearish side for the intermediate and short term.

Our internal indicators are grossly oversold, and so the likelihood of a bounce this week is high, but the downtrend should ultimately produce a minimum target for the S&P 500 of 1,258.

Russell 2000 Chart
Click to Enlarge

The Russell 2000 small-cap index shows a similar pattern to the S&P 500. A head-and-shoulders breakdown is even more graphic on this chart than on the S&P 500’s. The target calculated from the breakdown gives a minimum downside target of 724. It, like the S&P 500, is now very oversold and so a near-term bounce is likely.

The Relative Strength Index (RSI) is one of the most reliable internal indicators. On both of these charts, the RSI shows that August’s sell-off produced the lowest reading in the last 10 months — and both were under 20, the number usually considered as the “oversold standard.”

Even though there was another spike down in early October, the RSI had told us that support existed in the general area of 1,125 for the S&P 500 and 650 for the Russell 2000. Since the RSI hasn’t yet broken the 20 line, it is saying that the bottom has yet to be made and that the ultimate low could be even lower than the estimates calculated from the head-and-shoulders formation.

Conclusion: Several major indices have fallen so sharply as to break their 200-day moving averages and exceed a 10% drop from their recent highs. Thus, some technicians are claiming confirmation of a bear market.

The Russell 2000 index of small caps lost 3.2% on Friday, bringing its total loss from its high to 13%, and the Nasdaq fell 2.8% and is 12% off of its March high. But 10% to 15% breaks are common, and so are violations of the 200-day moving average. In fact, both conditions occurred last summer without producing a bear market.

The overall trend is still up, despite short and intermediate downtrends. But volatility is increasing (VIX at 26.68), and so a wild summer with many trading opportunities lies ahead.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

Article printed from InvestorPlace Media,

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