Market Needs Rest After Volatile Week

Today I am going to do something a little different for the Morning Note, a more macro look at what has transpired in 2013 so far. Futures are near the flat-line this morning as the Nikkei bounced back almost 2%, so I thought it would be could time to take a step back and look at things through a slightly longer-term lens.

For the past two years I’ve been pounding the table about S&P 1700 by 2015 (starting around S&P 1300ish). About two months ago many wire houses started to raise their one year expectations for the S&P right as the markets started to get a bit overheated.

On May 22 we had an “outside day” bearish reversal, which is a strong technical signal. I sent out a note that it was time to take “risk off” and maybe even look to short I th at is part of your arsenal. In the short-term, that reversal has changed the pace of this bull market, but I don’t think it will mark a top. However, current choppy, indecisive action right now tells me this is a time to be very flexible.

So far we’ve had a 5% move off the highs and held onto the 50-day by a thread twice. The S&P is still up 14% year-to-date. Volatility in foreign markets like Japan has been much more extreme; the Nikkei, after being up 50% for the year at one point, has now pulled 20% off its highs, a level that some consider “bear market territory.”

Within this pull-back there have been “rolling corrections,” meaning the downside corrective action hasn’t come in one fell swoop. Rather, the correction has happened in waves, giving traders tactical areas to perhaps play short-term bounces and then potentially get short again into key resistance levels.

The question now is, can we hold the 50-day moving average build on a bounce and see bulls wrest back some control of the market? Obviously nobody truly knows the answers to those questions, but you can draw out a roadmap, which is what we have done for our community. I personally would like to see a move down to the 100-day MA around 1576ish. If we end up going below that, the 200-day MA stands at around 1500. After yesterday’s snap-back, those levels seem less likely to be hit, but next week should be interesting.

The hot-topic recently that has been driving the market has obviously been “QE tapering.” Some think the Fed may be tugging on the reins too early (at least with their tone), but I think they have done a good job of reshaping expectations before shocking the market with smaller asset purchase and potentially higher rates in the future. The fact that we have had rolling corrections instead of shock corrections like we have seen in Japan is evidence, I think, of good maneuvering by our Fed (at least better maneuvering than Japanese policy makers).

The June Fed meeting will be held June 18-19 with a Bernanke press conference scheduled for Wednesday afternoon 6/19 at 2:30pm ET. This announcement will probably be among the most important events of the entire month of June and will be Bernanke’s first major address since his last Congressional testimony. At this point most assume tapering will occur this year, but many questions are still unanswered, includin g: 1) will the Fed begin the taper this early? There are only two more such meetings in 2013 after June (9/18 and 12/18); 2) how large will the first taper be? Most are thinking somewhere in the $15-20B range; 3) will the Fed taper an equal amount between mortgages and Treasuries? Most think at first it will; 4) has the Fed formulated an updated exit strategy? Specifically, what is the current thought process on asset sales? Some Fed officials have hinted lately they may never sell any securities out of the QE portfolios – will Bernanke have an update during the 6/19 press conference?

I think the Fed watches the stock market more than many believe, and I think the reaction of the stock market is more important to them than they let on. I don’t think that they are technical analysts, but I do think that if we continue to hold the 50-day over the next few weeks and resume the uptrend, they could start tapering in the September meeting, perhaps from $85 billion down to $50-60 billion

If we pull-back further over the Summer into the 100-day MA (1576) or 200-day (1500), economic data remains mediocre, and inflation remains under control, I think they could put off tapering until perhaps early 2014.
The US economy is taking small steps in the right direction, so I think the Fed will match that with small steps out of such accommodative policy. It certainly won’t be all or nothing.

Japan, as I discussed, has shown unhealthy volatility thanks to aggressive intervention from its policy makers, but in the grand scheme has still had a tremendous year. All is not lost yet with the Nikkei despite the 20% correction off highs. The next big event for that nation will be elections on July 21, which will tell us how much the people buy in to the unprecedented “Abenomics.” Until those elections, I think you will see the same type of choppy action that we have seen recently from the Nikkei.

Traders embrace corrections because they provide a great opportunity to identify relative strength. At this point, the financial and retail sectors still act best, while the homebuilders have been among the weakest stocks in the market.

I personally do not think the highs of the year are in, but if you trade from an intermediate-term timeframe, I think you can get better entries over the Summer than we are seeing today. The 1540-1576 level could be the area to play a bounce if we can get a close below the 50-day MA.

I talk about the difference between a short-term tactical approach and a more swing trading-oriented “portfolio approach,” which I have tried to stick with for most of the year as indices have held above their 8- and 21-day moving averages for the most part. The conditions of the market right now are much more conducive to a short-term approach that provides flexibility.

Disclosure: Scott J. Redler is long AAPL, YCS, BAC

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