Be Prepared for a Panic-Driven Correction

by Sam Collins | November 6, 2013 2:04 am

On Tuesday, stocks closed mixed as uncertainty regarding the Federal Reserve’s future policies, poor economic numbers from China, and European malaise dampened buyers’ enthusiasm.

The Institute for Supply Management’s (ISM) non-manufacturing purchasing managers’ index (PMI) for October rose to 55.4 from 54.4 in September. And the ISM employment index was better than expected at 56.2, up from 52.7. But the positive numbers had the opposite impact on stock prices, since better economic numbers might persuade the Fed to begin tapering.

Tesla Motors (TSLA[1]) fell in after-hours trading following a Q3 earnings and revenue report that failed to meet expectations. CVS Caremark (CVS[2]) rose 2% on better Q3 results, and AOL (AOL[3]) jumped 8.5% on better revenues.

At Tuesday’s close, the Dow Jones Industrial Average fell 21 points to 15,618, the S&P 500 lost 5 points at 1,763, and the Nasdaq gained 3 points at 3,940. The NYSE traded 742 million shares and the Nasdaq crossed 470 million. Decliners outpaced advancers on the Big Board by 2-to-1, and decliners were ahead on the Nasdaq by 1.4-to-1.

NYSE Chart
Click to Enlarge

Chart Key[4]

The NYSE Composite has formed a small reverse “V” at the top of its bull channel. The “V” has a support line at 9,964.

This index, which contains all stocks listed on the NYSE, often provides the first clue that something is about to happen. A break of the support line would immediately challenge the 20-day moving average at 9,934 and probably take the index down to at least its 50-day moving average at 9,727.

This is all “trader stuff” and doesn’t threaten the overall trend of the bull market. But a fall like that could have an impact on other indices and provide for the long-awaited correction. Note that the Composite’s MACD flashed a sell signal Monday.

VIX Chart
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Following last week’s taper scare, the CBOE Volatility Index (VIX) went back into hibernation. Those who claim that the market has been running solely on earnings should rethink that position, since this index clearly shows the impact of just a minor threat of changing the Fed’s bond-buying policy.

Conclusion: Analyst Josh Levine has it right in his latest weekly letter when he refers to the recent complacency: “This comfort stems from an economy that is chugging along at a tepid pace, but with enough backwinds to assure that corporate profits will remain solid. Alternatively, the economy is weak enough to keep the US Federal Reserve on pace to keep intervening in the bond market.”

Yes, and it is this Fed strategy that leaves little choice for investors who are getting no return from money markets, CDs and bonds. They must go to stocks, and that’s what assures us of a continuation of a bull market.

However, with 71% of all stocks on the NYSE and ASE now above their 50-day moving averages (70% interpreted as overbought), flashes of panic as evidenced by the VIX, and many possible catalysts for a sell-off, we should be prepared for a panic-driven correction and not become overextended in high P/E stocks or margin debts. Discretion is the better part of valor.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[5].

For a list of this week’s economic reports due out, click here[6].

  1. TSLA:
  2. CVS:
  3. AOL:
  4. [Image]:
  5. click here:
  6. click here:

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