To round off the month of January and kick-start February, the U.S. stock market last week offered a wake-up call for complacent traders and investors alike: stocks don’t only go up. Investor complacency by many public measures as well as my own proprietary tools in January reached bullish extremes and so it was only a matter of time until stocks began to correct.
In last week’s opening missive for Monday I offered that the plethora of major economic data and corporate earnings could lead to a spike in volatility. As I have been offering to my clubhouse members and coaching students in recent weeks, prudent investors were clipping and trimming their near-to-intermediate-term long positions through the lens of prudent risk management into the vertical climb that was most of January 2018. Put differently, money in the stock market over time is not made by reward chasing markets higher or lower but rather by sound risk management decisions.
So you know, my main stock market theme for 2018 is that we will see the return of volatility, which is not to be confused with a big time market melt down. The harsh reality is that a good part of 2016 and all of 2017 was an anomaly of an environment where stocks continuously grinded higher on almost no volatility.
To wit, in rampant bull markets, a simple but effective strategy is to just remain long broader stock market indices. The issue investors run into is when the market environment changes and they don’t recognize this or choose to stubbornly ignore it. That is where fortunes made during strong bull markets quickly vanish, which leads to unnecessary emotional distress on the part of many individual investors.
And so it is my hope that last week’s stock market correction served as a wake up call for investors that stock prices can indeed also go down.
From where I sit, a medium-term top for stocks may have been put in last week and it is now likely to get notably more difficult; its been way too easy for the past 18 months.
Moving averages legend: red – 200 week, blue – 100 week, yellow – 50 week
A glance over at the weekly chart of the S&P 500 as represented by the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) shows a notable bearish reversal candle last week which in just a few trading days erased the gains of more two weeks prior. Through the lens of investor psychology, the bulls simply ran out of energy last week and when there are no buyers left stocks have no choice but to slip into a consolidation phase.
On the chart note that last week’s bearish reversal also pushed the SPY etf back into the well-defined up-trending channel. The index remains notably overbought even after last week’s reversal, which is to say that some further downside and/or backing and filling is the likely course forward for the near to intermediate term,
What is the next possible near-term downside target for the SPY ETF you ask? One could use a simple 50 day moving average as next downside target. This moving average currently resides around the $271 mark, or about another 1.60% lower from last Friday’s close. To be very clear, that is just a reference point and hardly a trustworthy point for a “low” in the market.
Last week’s drop in stocks of course came bundled with a spike in volatility as represented by the VIX. Note that the VIX last week tickled levels last seen in November 2016, which however through the longer-term lens does still not mark any real panic levels.
So you know, last week on January 30th for clubhouse and coaching clients in real time we offered a short-side idea in the iShares Russell 2000 Index (ETF) (NYSEARCA: IWM). I remain short the IWM etf for now, which is to say that I envision marginally lower levels still ahead for stocks in the near to possibly intermediate term.
In summary, at the very least last week’s spike in stock market volatility should have been a good wake up call for complacent investors and traders alike that the going has been too easy and is likely to get markedly more difficult (but not impossible). Active management is now likely back as the method of choice for navigating to stock market profitability.
Check out Serge Berger’s Trade of the Day for Feb. 5.
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.
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