Unless you spent all day and night yesterday in a cave, you’ve already heard the results of the disastrous trading session from every major media outlet in the world. So, let’s cut to the chase. . .it was simply atrocious! After gapping sharply lower on the open, stocks began selling off even further, then never looked back. For the first time in years, trading curbs that attempt to control a free-falling market were put into effect, but the results were abominable nevertheless. The Nasdaq Composite suffered a 3.9% loss, the S&P 500 3.5%, and the Dow Jones Industrial Average 3.3%. The small-cap Russell 2000 swooned 3.8%, while the S&P Midcap 400 slid 3.1%. On top of all that, the major indices even closed off their intraday lows! Around 3:00 pm EST, a tidal wave of sell orders hit the market when curbs were lifted, briefly sending the Dow to a loss of more than 550 points (4.4%), but the index finished the session “only” 416 points lower.
Needless to say, astonishingly higher turnover indicated aggressive selling of stocks by mutual funds, hedge funds, pension funds, and other institutions. Volume in both exchanges rocketed to their highest one-day levels since July of 2002, when the preceding two-year bear market began to put in a bottom. Total volume in the NYSE surged 55% above the previous day’s level, while volume in the Nasdaq increased by a whopping 62%. The real kicker, however, was the unbelievably weak market internals. In the NYSE, declining volume annihilated advancing volume by an extraordinary margin of 103 to 1! Approximately 2.5 billion shares traded hands in the NYSE, but only 24 million of those shares were on stocks that gained. The adv/dec volume ratio in the Nasdaq was negative by 20 to 1, only slightly more palatable. Only two stocks in the entire S&P 500 Index closed higher. None of the thirty stocks that comprise the Dow managed to eke out a gain.
The popular financial press is blaming yesterday’s sell-off on Monday night’s 9% decline in the Shanghai market. However, we feel it was actually a “perfect storm” of three events that triggered the slide. Given that many of the current leading stocks in the U.S. market are ADRs of mainland Chinese companies, the Shanghai collapse was indeed a significant factor in the U.S. decline. But Alan Greenspan’s warning of a possible U.S. recession the previous day undoubtedly created a bit of fear as well. Although he is no longer at the helm of the Federal Reserve Board, his comments remain widely respected and still have the power to move markets. Most of all, however, the third factor in the “perfect storm” was the precarious state of the stock market before either of those two events occurred.
Long-term readers of our daily commentary know that we have felt something has been wrong with the markets for the past several months. The major indices kept making new highs, but each time lacked the proper momentum to convincingly follow-through to the upside. Conversely, every downside correction turned out to be short-lived and failed to fall very far before grinding back to the upper end of the range. This dangerous complacency amongst investors, and the resulting erratic market behavior that accompanied it, is the reason we have been advocating a mostly cash position and minimal market exposure for at least the past two months. It’s convenient to blame China or Greenspan for yesterday’s dire selloff, but the reality is that both events were merely the stimuli to ignite an inevitable correction.
In the February 5 issue of The Wagner Daily, we warned that the market was looking very extended in the intermediate to long-term because the S&P had registered eight consecutive months of gains without a correction. Recall the following commentary that accompanied the monthly chart of the S&P 500 in our February 5 newsletter:
“As you can see, the S&P has been trending steadily higher for nearly four years, since about the middle of 2003. From 2003 through 2006, a clearly defined trend channel developed, which is illustrated on the chart above. Until the end of 2006, every rally into resistance of the upper channel was followed by an eventual move down to support of the lower trend channel. But since November 2006, the S&P has been trading above resistance of the upper trend channel. Furthermore, January marked the eighth consecutive month the index has closed higher. The last time the S&P managed to gain for eight months in a row was from November 1995 through June 1996, more than ten years ago! During that period, the S&P 500 rallied 15%, but the ninth month was nasty. In July of 1996, the index plummeted as much as 9.7%, more than 60% of its eight-month gain, before closing the month with a 4.6% loss. Curiously, the current eight-month winning streak in the S&P stands at a very similar 14% gain. Obviously, we have no way of knowing if this history will repeat itself this month, but this historical information should at least serve as a reality check for bulls who are fearlessly buying at current levels. The parabolic rally above the upper channel of the long-term uptrend, combined with the fact that the S&P has not seen a meaningful correction in nine months, should serve as a yellow flag for astute traders. We’re not advocating fighting the long-term uptrend, but merely warning against a stock market killer named “complacency.”
Obviously, it was impossible to pinpoint the exact day the correction would begin, but being cognizant of the technical “big picture” enabled us to be conservative and avoid losses yesterday. With only one day remaining in the month, it indeed appears that history is repeating itself from the period of November 1995 through June 1996 mentioned above. If the S&P loses just 1.1% more today, the total gain of the current eight-month winning streak, along with the subsequent loss that followed in the ninth month, will be nearly identical to what last occurred more than 11 years ago! If nothing else, we find that obscure observation to be very interesting and thought-provoking.
Now that a substantial correction is obviously under way, let’s take an objective look at how far the retracement is likely to go before the S&P finds major price support. To do so, we will again utilize the long-term monthly chart of the S&P 500:
Because it was so extended above support, yesterday’s 3.5% loss merely took the S&P down to the UPPER CHANNEL of its long-term uptrend. Based on the nearly four-year uptrend that remains intact, the index should retrace down to the lower channel support, presently just below the 1,300 level. There will be bounces along the way, but it’s completely reasonable to assume the S&P will correct down to the lower channel. A steady downtrend to that level over the next several months would be ideal because it would provide us with clear trade setups on the short side. However, a more rapid drop to that level would be much trickier to trade.
As for our positions, we were fortunate enough to be on the short side of the market, albeit with only one position, going into yesterday morning. On Monday afternoon (February 26), we initiated a short position in iShares China (FXI) when it failed to recover back above its 50-day MA and fell below the prior day’s low. We certainly didn’t expect it to happen only one day later, but FXI fell to our downside price target of the January 10 low shortly after yesterday’s open. We locked in a gain of nearly 8 points on the FXI short position. The daily chart below shows how FXI actually exceeded our price target by several points, but we followed our plan and covered the position at the pre-determined price:
When the Dow broke below support of its 50-day moving average yesterday morning, we quickly sent an intraday e-mail alert to subscribers, informing them we were buying the inversely correlated UltraShort Dow 30 ProShares (DXD) at a price of $57.57. Given the amazingly weak market internals at the time, we figured it was a low-risk play to “test the water” on the short-side of the market. With an upside price target of the prior high of November 28, we anticipated a time horizon of several days to a week. But to our surprise, DXD hit the target of $61.10 several hours later, locking in a gain of 3.6 points intraday:
With just those two positions in FXI short and DXD long, we had a very profitable day and are once again flat. We’ll be scanning for new short setups over the next several days, but want to first give the market a chance to digest yesterday’s losses.
Regardless of how long it takes for the S&P to correct down to major support, one thing is certain — yesterday’s change in overall sentiment was extremely severe. Because the odds of profiting from the long side of the market are so negative, we are no longer looking at buying ANY ETFs that are directly correlated to the movement of the equities markets. Currency, commodity, and fixed-income ETFs are the exclusions. If you are still sitting on long positions that you failed to close yesterday, consider selling into the strength of any bounce over the next day or two. We also strongly recommend having a definitive “line in the sand,” a price level at which you cry “mercy!” and immediately sell without thinking. In case the expected bounce never comes and panic selling subsequently overcomes Wall Street, your “line in the sand” will prevent small losses from spiraling into catastrophic losses that cause unrepairable damage to your trading account. Be disciplined to follow your plan because now is definitely not the time to fall into “hope” mode!
There are no new pre-market setups today, as we first want to see how the market digests yesterday’s melee. Be on the lookout for an e-mail alert if we spot any ideal trade setups intraday.
Daily Performance Report:
Below is an overview of all open positions, as well as a performance report on all positions that were closed only since the previous day’s newsletter. Net P/L figures are based on the $50,000 Wagner Daily model account size. Changes to open positions since the previous report are listed in red text below:
Open positions (coming into today):
Closed positions (since last report):
FXI short (200 shares from Feb. 26 entry) –
sold short 105.38, covered 97.41 (avg.), points = + 7.97, net P/L = + $1,590
DXD long (450 shares from Feb. 27 entry) –
bought 57.57, sold 61.18 (avg.), points = + 3.61, net P/L = + $1,615
Current equity exposure ($100,000 max. buying power):
FXI hit our price target shortly after yesterday’s open. Because downside momentum was so strong, we actually got filled at a better price than our limit cover order at the target price. Per intraday e-mail alert, we also bought DXD yesterday morning. Just after 3:00 pm EST, we sent another intraday alert stating we were taking profit on the position because it was already nearing our price target. However, by the time the alert was sent, DXD had already traded through our target price. We were filled above the ask at an average price of 61.18. It may have been a tough day for long-term investments, but it was a good day to be swing trading short-side momentum.
Edited by Deron Wagner,
MTG Founder and