Stairs Up, Elevator Down Market

World markets reacted overnight to the major reversal in US markets yesterday and are down big this morning. Japan is getting hit the hardest, down around 7%, although it was up more than 50% for the year so far. The negative feedback loop also circled back to US futures, with the S&P e-minis down 15-18 handles this morning. Yesterday we sent out an alert in the afternoon talking about the significance of yesterday’s outside reversal, topping tail candle, and now its validity is being confirmed by the sharp drop in the futures.

Yesterday we had a perfect storm scenario to finally trigger the long-awaited 2013 pullback. The market was very extended from its short-term moving averages and outside its Bollinger Bands, with the S&P up 18% in less than five months to start the year. Then, you had Fed Chairman Ben Bernanke testifying in front of Congress followed by the Fed minutes. Many investors, I think, we wary of those two events given the recent rhetoric about QE tapering, and it appears big institutional players elected to take some profits before and during those events yesterday.

If you had been carrying multiple long positions, it was prudent to book some profits at levels we saw yesterday morning. In fact, many prudent active traders may have already cleaned up many of their long positions given how far the market and individual stocks had run.

Now, the question is how far will be pull-back? Will we be reminded that we operate in a “stairs up, elevator down” market, and quickly give back much of the gains from May? We will first be watching the 21- and 50-day moving averages in stocks and indices to see whether those levels can hold, and if they can’t we will start looking deeper down the chart.

With the tempest set to hit the markets today, new data likely won’t play a huge role in driving the action, but be aware that we have Jobless claims at 8.30AM ET and new home sales at 10AM ET.

Pull-backs should be welcomed by bulls and bears alike. We like to see pull-backs as part of a healthy market cycle, because it gives us an opportunity to identify relative weakness. In today’s session, keep a close eye on which sectors hold up best and bounce first.

XLF (NYSEARCA:XLF) saw a push-through failure at $20.14 yesterday and touched its 8-day moving average at $19.75. The ETF put in a big engulfing bar as the banks showed some signs of exhaustion. The 21-day comes into play at $19.31. I will be very interested to see how the banks react, because they could very possibly show relative weakness today. MS is one stock that I think could show weakness within the sector as well. GS is also worth watching, as it can often lead the market up and then lead it down soon after.

XLI (NYSEARCA:XLI) saw a push-through failure at $44.55 in the morning then the selling intensified in the afternoon and sent the stock all the way down to its 8-day MA. XLI had gave back the previous three sessions’ gains. Could we see lower prices? The 21-day is curling up at $42.95.

IWM (NYSEARCA:IWM) also saw a push-through failure at $99.60 and has dipped below its 8-day after shedding 1.5% yesterday. The Russell 2000 ETF bounced back a little into the close, and put in a new pivot level at $97.11. Would the damage be contained at this level or will we see lower prices? The 21-day is standing at $96.35. Small-caps are often the first to get sold off when the market turns South, and the IWM has shown relative weakness during some of the shallow 2013 pullbacks. Watch to see if it shows relative weakness today.

RTH (NYSEARCA:RTH) didn’t see a big engulfing bar like other sectors but also touched its 8-day moving average. RTH has been climbing this key short-term moving average up. A break and close below this at $52.56 would take it to the 21-day at $51.76. Given the relative strength in this group, perhaps look for some of the strongest stocks within it for bounce plays. UA is one that has been extremely strong this year and could be a worthy dip buy.

Stocks within the high beta tech group have diverged from each other considerably of late, so take a stock specific approach with these.

AAPL was the only on my usual high beta tech list that finished in positive territory, continuing its recent inclination to trade inverse to the market. AAPL registered gains of 0.4% yesterday after seeing a nice push into the close. Yesterday’s low of $438.22 gave us a new point of reference to watch. Below this we have the 50-day at $435.65. It’s hard to know what to expect from AAPL given its recent erratic nature, but it’s worth watching after yesterday’s show of relative strength.

GOOG gave the first warning signal when it saw a push-through failure at $916 last Thursday. Then yesterday the stock filled the gap from the prior Wednesday to the downside with a 2% loss. See if GOOG can hold onto the 21-day at around $868.81.

AMZN gapped down at the open yesterday and couldn’t fill the gap as the stock headed lower by more than 2%. The stock already dipped below the 38.2% Fibonacci retracement level of the recent rally. For it to stay out of trouble, it needs to hold the 50% level at $258. AMZN may not be strongest enough to hold up in today’s market storm.

LNKD retraced 4% yesterday and broke below some key moving averages, including the 50-day yesterday. This one has shown relative weakness since its most recent earnings report, which was a rare disappointment for a company that had made a habit of beating Wall Street expectations. The positive results had made the stock a momentum darling, but I think the narrative has now changed. The $165 level is the last line of defense to keep it out of trouble, but I think if you are looking to add some shorts on today’s down open–which could be tricky–this is one of the best short set-ups out there.

NFLX has been showing some signs of exhaustion, which we highlighted in a few previous Morning Calls videos. The stock saw a big down move yesterday as it retraced 3.6% and broke below its 8-day moving averages. The 21-day is standing at $220.50. Watch to see how far we retrace in NFLX, as it could be another to see some air come out.

When a frothy market finally succumbs to weakness, often times the frothiest sector and stocks are the first to get pummeled. Yesterday we saw that with the solar sector and some of those “high short interest stocks” getting hit hardest. Let’s see how that group reacts today.

SCTY got hit hard during the market’s pull-back yesterday. The stock did open higher yesterday though, so similar to the market, the percentage loss on the day does not tell the whole story about the extreme intraday selling. I think because of the Elon Musk effect this stock got a bit overheated, and we could see a deeper pull-back. After a parabolic move, it gave back almost 50% of the recent gains within two days. If it doesn’t hold the 8-day at around $40.54 we could see some more sellers stepping in. Other stocks in the solar sector like SPWR got hit hard yesterday, too, and should be on the radar today. If they pull-in too far, they could also present buying opportunities, so be flexible and obey price action.

GLD continued its erratic price action yesterday, gapping up but failing to hold its overnight gains. The ETF put in a potent red bar like the market and macro composure remains very bearish. GLD is up around 2% this morning, though, as panic hits global markets, so keep an eye on it.

Overall, on volatile days like this it is best to narrow your focus to a smaller number of stocks and focus more on the indices. In general, I don’t think traders have a huge edge when trading broad indices, but today could be a day where you focus more on the SPY and a select number of stocks in key sectors you are watching. Cash is also a position, so if you are not comfortable stepping in during extreme volatility, wait for things to settle out.

Disclosure: Scott Redler is long AAPL, BAC. Short SPY.

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