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Was That the Correction, or Is It Just Beginning?


Three reasons for the bearish rhyme.

Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.

There was a global theme surrounding stateside markets this weekend as investors looked to assign a reason for Friday's downside rhyme.

The first -- and most intuitive -- culprit for the fugly backhand slap was that the market were "rebalanced," a structural shift in equity weightings, on the close of a thin summer Friday session as many market participants -- and much of the liquidity they provide -- were already on their way to the beach to find relief for the near triple-digit temperatures on the East Coast. (See: Cold Spell for a Hot Market.)

The second reason can be found in the Far East, where the Japanese Nikkei (INDEXNIKKEI:NI225) is now down 20% -- the traditional definition of a bear market -- following the scorching rally that added 84% to the mainstay average since November.

This time is different for Japan, right? Well, maybe. Since the Nikkei stock market bubble burst on New Year's Day 1990 -- at a level of almost 40,000 -- we've see rally attempts of 22%, 37%, 50%, 36%, 60%, 62%, 138% and most recently, from November of last year until late May this year, 84%.

And of course, we've got the Hindenberg Omen, which "confirmed" on May 29. Some top line facts on this bearish technical signal:
  • It portends a sharp drop in stock prices within the next 40 days.
  • The last signals were in July and October of 2007.
  • Omen confirmed if there are two trading days within 30 days of each other where, on the same day, 10-week moving average is rising, New Highs are greater than 2.2% of total issues traded, New Lows are greater than 2.2% of total issues traded, and the McClellan Oscillator is negative. (Courtesy Bloomberg).
On May 20, we shared A Signal That Bears Watching, which suggested a double-digit percentage downside move.

A few days later, we asked whether the S&P can trade to 1500, highlighting the yawning chasm between stocks and commodities.

And last Thursday, we flagged a pattern in the S&P (INDEXSP:.INX) that suggested that IF S&P 1635 was breached, we could see S&P 1595-1600 in short order. S&P 1635 was of course breached on Friday.

I entered Friday with S&P short exposure -- in full disclosure, I've been trading from the short side for some time -- and didn't cover up into the sharp slippage late Friday. My sense was that even if the S&P futures were +8 (as I posited they might be Friday night on Twitter), the tape tends to probe the previous direction following an outsized move. The risk to this approach would be a "gap and go" higher, and that was a risk I was willing to take.

Now, to be clear, this entire column -- and I would offer that any traditional analysis -- must have an asterisk in the System Formerly Known as Capitalism. Between central bank intervention and High Frequency Trading, the markets are far from free or level-fielded. John Q Public believes the markets are rigged because the markets are rigged, if by rigged we mean they don't trade freely on the laws of natural supply and demand.

That's not a hedge; that's the world we live in and we must trade the tape we have, not the tape we want. My sense is that S&P 1600 is a 'first stop' but of course, that's just one man's humble opinion. We're currently trading at levels last seen all the way back on May 13, so keep it in perspective as we together find our way, one stair-step at a time.

Good luck.


Twitter: @todd_harrison

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