It is remarkable how fast the narrative has gone from “Sell everything because the yen-carry-trade is blowing up” to “Buy everything because the Fed will save the day.”
The financial media talking heads were screaming last week for the Fed to call an emergency meeting and cut rates immediately in order to stave off a recession. Now they’re championing the brilliance of the Fed to manage a soft landing – allowing it to start lowering rates at a comfortable pace beginning in September.
Meanwhile, traders who dumped everything and bet aggressively on the short side last week are rushing to buy everything back and get aggressively long the market this week.
My guess is they are about to get whipsawed again.
Take a look at this chart of the S&P 500…
The index trades today at basically the same level it was at two weeks ago. So, if you fell asleep at the start of August and woke up today, it would seem like nothing much has happened.
But last week’s decline was strong enough to pull the moving averages into a bearish configuration – with the 9-day EMA below the 20-day EMA, and the 20-day EMA below the 50-day MA. The momentum indicators at the bottom of the chart all dropped into oversold territory. And the index itself dropped to another lower-low.
All of that gave traders a good setup for an oversold bounce – which is what has happened.
We should note, though, that so far the action looks similar to what happened last September. Back then, the decline led to an oversold bounce. But that bounce ended as the S&P bumped up against its 50-day moving average line. The S&P 500 then sold off one more time to a lower-low, while the technical momentum indicators all formed slightly higher lows.
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That “positive divergence” set the stage for a stronger bottom, and a more significant intermediate term rally.
The rally so far this week has propped the S&P 500 back up to its 50-day MA. And it has pulled the momentum indicators out of “extremely oversold” territory. Now they’re closer to neutral.
The index, though, is still inside its pattern of lower lows and lower highs. If it can close above the 5540 level then we can re-evaluate the possibility that last week’s action marked a bottom for this decline phase.
For the moment, though, if the market follows the same script as it did last September, then this bounce has just about run its course. The next move is more likely to be lower.
If we get signs of positive divergence on that next decline, then traders should look to add to their long exposure in anticipation of a more significant intermediate term rally.
Best regards and good trading,
Jeff Clark
Editor, Market Minute