Buyers, Don’t Be Shaken by the Sell-off

by Sam Collins | September 26, 2012 1:11 am

Positive consumer confidence numbers before the bell led to a strong opening. But it was not to last as weakness in crude oil and a criticism of recent stimulus efforts from a Fed official turned the advance into the worst day for the S&P 500 in three months. A better-than-expected rise in July home prices held back some early selling, but end-of-quarter profit-taking and more European uncertainty probably had a negative impact.

At Tuesday’s close, the Dow Jones Industrial Average lost 101 points at 13,458, the S&P 500 fell 15 points to 1,442, and the Nasdaq was off 43 points at 3,118. The NYSE traded 755 million shares and the Nasdaq crossed 458 million. Decliners exceeded advancers by about 2.7-to-1 on both exchanges, but more importantly, an imbalance of selling volume at 9-to-1 signified moderately heavy institutional selling.

VIX Chart
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The chart of the CBOE Volatility Index (VIX), also known as the fear index, shows that investors have moved from the slumber of complacency to wide-awake concern. With a rise in the index of 12% in just three days, traders are now alerted that a deeper correction could follow.

For new readers, the VIX measures the expected volatility over the next 30 days, and it is a contrarian index, i.e., when it goes up the market usually goes down.

DJT Chart
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Trade of the Day Chart Key[1]

We’ve highlighted the Dow Theory divergence several times this month, i.e., the failure of the Dow Jones Transportation Average to confirm the new high in the Dow Jones Industrial Average. This is considered a negative, and until it is resolved by both indices making new highs, or lows, it is interpreted as a cautionary yellow flag to those who follow the theory.

The yellow flag could turn to pale red if the transports break below the close of June 4 at 4,848. But it could also turn green if it closes above its double-top at about 5,360 made earlier this year.

Note that the transport’s MACD is now oversold, which may indicate that after piercing its recent low it could reverse up and the broad advance could resume.

Conclusion: Although technically the breakout of the S&P 500 to four-year highs was as perfect as it gets, we should expect profit-taking and negative news to cause days like Tuesday. Concern will be hyped by the press as a normal correction develops. For example, CNBC spent 20 minutes on the Dow’s divergence Tuesday, although it was hardly mentioned in the news until now.

You may have noticed that the pundits are usually most bullish at the top and bearish at the bottom. Ignore them and let the market tell you its direction. That direction is now up, so fear-based corrections should be considered buying opportunities.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[2].

For a list of this week’s economic reports due out, click here[3].

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