U.S. Stock Market: Is The Correction Over Already?

From its all-time record high at 1991.39 on July 24th, the S&P 500 Index corrected 4.35% to a low last Thursday at 1904.78. The Russell 2000 Index had a more serious correction from its record high at 1213.55 on July 1st. This benchmark of small-cap stocks fell 8.75% to its recent low at 1107.30 on August 1st. And the Nasdaq Composite Index fell the least recently, posting a correction of just 3.65% between July 25th and August 7th.

Is the correction over now? 

Not likely in my view!

If the overnight price action is included in yesterday's activity (Friday, August 8th), then most major U.S. stock market indexes posted a one day range of approximately 2%. Given that there have been very few daily ranges greater than 1% this year so far, yesterday's volatility is noteworthy.

The financial press highlights two major announcements as the catalysts for Friday's extreme price action. Late Thursday, the Obama Administration announced that the U.S. will provide humanitarian aid and also initiate military action (air strikes) in Iraq. The S&P futures promptly dropped 20 points (about 1%) on this news. Then early Friday morning, the Russian government announced that it was prepared to take actions that would relieve tensions in Ukraine. The S&P futures reacted immediately and rebounded to plus territory prior to the NY opening. After a relatively flat U.S. opening on Wall Street, stock prices found a strong bid and then rallied sharply to post exceptional gains of approximately 1% across-the-board.

On a technical basis, if we include the entire 24-hour range from yesterday, the S&P 500 Index found major support at its 150-day moving average line. For additional support, there was also an uptrend line in the S&P 500 Index that goes back almost two years, and there was also a 3-standard deviation lower Bollinger Band very near the bottom of the early A.M. Friday overnight range.

With respect to my managed accounts, on Thursday night I remember thinking clearly that Friday would probably be a monster plus day for me (with my significant S&P 500 short position). Even though I knew ahead of time that major support was lurking about 1% below Thursday's NY closing prices, I wasn't sure how I was going to react to Friday's expected lower opening. In my imagination, I was thinking "complete collapse of the system", but in my gut I knew that maybe I should respect these key support levels and lock in the significant paper profits that I had accumulated in recent weeks. 

Early Friday morning, when Russia announced (for the 10th time) that maybe it would "step back" from the brink of all-out war in Ukraine, paper profits in my S&P short positions evaporated and soon turned to losses against the prior day closing prices. It was an especially long ride to work Friday morning, as Bloomberg radio announced every 10 minutes that S&P futures were rebounding sharply into positive territory following steep overnight losses. My window of opportunity to lock-in exceptional profits was gone, and now I had to decide whether or not to "take the pain" of any potential rally over the short-term horizon or liquidate with decent profits on the overall trade of the last several weeks. When I was younger, I am sure that I would have "stuck to my guns" and rationalized a strategy for keeping my shorts and risking "minor" short-term losses in favor of major possible gains in the new bear market that I have proclaimed in the strongest of terms that is now underway. But now that I am older (and maybe just a little bit wiser), I liquidated my entire S&P 500 short position within 10 minutes of Friday's NY opening. Of course, in hindsight, covering my shorts turned out to be a very fortuitous trade, but 35 years of instinct was all that save me yesterday from a giant single-day loss. Even after the fact, I still can't see the justification for the incredible 2% rebound off yesterday's overnight intra-day lows. 

So where to we go from here?

A daily chart buy signal was triggered by my computer trading system in the Dow Jones Transportation Average yesterday (please see chart below). This key stock market barometer had declined about 7% from its July 23rd peak to yesterday's intra-day low. Even though I strongly believe that the monthly chart sell signal in this index is the dominant signal (see chart below), we should probably respect the shorter-term daily chart buy signal for at least a few days, to clear the air and determine if any possible rally here has legs.

Bottom Line: I think U.S. stock prices will move sideways to slightly higher over the next few days and then resume the downtrend that began in July. My best forecast here is that the 50-day moving averages in most major indexes will NOT be exceeded on this rebound before the primary bear market resumes in earnest later this coming week. Cash is KING right now! I see very little upside potential in T-Bond prices, and I don't even want to own Gold, Silver, or related precious metals mining shares right now. I further believe that conditions are now ripe for a minor liquidity squeeze to develop over the very near term as the negative impact of the Fed's 8-month old "taper of QE" becomes more apparent. And, to add insult to injury, I anticipate increasingly hawkish rhetoric from Federal Reserve officials in their speeches to the marketplace as they attempt to brace investors for upcoming interest rate hikes and tighter monetary conditions.

Dow Jones Transportation Average Daily Chart with 3-Std Dev. Bollinger Bands and Computer Buy & Sell Signals

Dow Jones Industrial Average Monthly Chart with 3-Std Dev. Bollinger Banks and Computer Buy & Sell Signals