Making sense of the selloff
Posted
Jul 02 2009, 05:11 PM
by
Anthony Mirhaydari
Rating:
Wall Street sure has a funny way of celebrating. We just wrapped the best quarter since 2003, had a rip-roaring start to the third quarter, and were heading into a long, sun-filled holiday weekend. In response, the S&P 500 lost 2.9% on Thursday with all the major sector groups falling more than 2%.
That's how the market gods like it: Maximum pain at the most unexpected time.
Over the past few weeks I've been waiting for a selloff based on depressed volatility measures and weak supply/demand fundamentals. Today, I had focused short positions among energy and industrial stocks. My portfolio is up 2% over the last two days versus a 1.7% drop in the S&P 500.
Now, let's talk about what happened and what's ahead.
First, volume was very light today after a lot of folks packed in early to be with family and friends. It figures that the bears, who are cynical people by nature, would say in the office and cause trouble while everyone else was working on their tan. Less than four billion shares were traded on the New York Stock Exchange -- the slowest trading session since New Year's Eve 2008. Thus, we should view the bears' achievement with a measure of suspicion.
At the sector level, energy and industrial stocks were the main victims, falling hard and early. Bank stocks, which haven't been moving much lately, suffered some late afternoon selling and were also weak. Looking at the Sector Select SPDRS, which represent S&P 500 stocks broken up by economic sector, energy stocks are the only group to have broken out of its June trading range. As you can see in the chart above, the XLE came to a stop at old resistance levels from back in March and April. A violation of these levels would mean big trouble for stocks like Chevron (CVX) as well as the broad market.
And finally, breadth was very negative. Advancers outpaced decliners 4.2 to 1 while down volume accounted for a whopping 93% of total volume. Traditionally, dramatic selloffs of this magnitude exhaust the supply of stocks and wear out the bears. Just think of the amount of energy and capital necessary to simultaneously push down so many stocks. As a result, big down days are normally followed by a feeble rally that lasts about a week or so as the bulls count causalities and the bears reload for another frontal assault.
But what's over the horizon? Sure, I could talk about things like earnings multiples or money supply growth, but at the end of the day what matters is the relationship between the supply and demand for stocks. And based on the work of Paul Desmond and his team at Lowry's, it looks like the pain is just beginning.
Over the past 76 years, Lowry's has found that new bull markets are characterized by a ground-swell of buyers. Unfortunately, despite the steepest market rally in more than seven decades between March and June, this hasn't happened. Since May 8, buying power has steadily fallen and now sits just a hair over where it was when the market bottomed on March 9. That's right: People are just as interested in buying stocks now as they were when the S&P 500 was plumbing the unholy depths of 666.
At the same time, sellers are making a reappearance. After being scared away by early signs of an economic recovery, recent data including today's dismal jobs report has empowered the bears and brought them back in greater numbers. Unless the bulls can regroup on Monday on high volume, we could be looking at the beginnings of a new downtrend that could possible retest the March lows. Stay tuned for new trading ideas on which sectors and stocks look the weakest.
Disclosure: The author does not own or control a position in any of the funds or companies mentioned.
Anthony Mirhaydari is a researcher for the Strategic Advantage investment newsletter. He can be contacted at anthony.mirhaydari@live.com. Feel free to comment below.
Related reading:
Oil prices are ready to fall
Consumer worrywarts threaten stock rally
Why gold stocks are a buy
Stock market vs. credit market: Which is right?
