This Bounce Should Last A Few More Days – Get Ready To Short
The market was overdue for a big bounce and yesterday we witnessed the largest gains ever for a single day. The Dow Jones Industrial Average was up more than 1000 points and stocks closed on their high of the day. Unlike a capitulation low where the market slingshots to a new relative high, this is only a bounce. Bearish sentiment hit extreme levels and shorts are running for cover. I believe this move will last a few more days.
Wednesday the SPY breached the low from Monday and it instantly reversed. The buying pressure was steady and we saw follow-through right to the closing bell. In my comments yesterday I told you that the second necessary component was follow-through the next day. In pre-open trading the S&P 500 is down 40 points. I’m not overly concerned about this pullback since we are simply giving back the gains from the last hour of trading on Wednesday.
At a forward P/E of 14, stocks were cheap. Master Card posted good holiday sales numbers and that provided a bullish backdrop.
Earnings growth rates will decline because the tax cuts took effect a year ago. However, profits will still hit record levels.
A US trade delegation will meet in China during the week of January 7. Both countries have suffered large market losses in the last few months and this should motivate negotiators. Trump plans to use his executive power to limit Chinese telecom penetration (ZTE) in the US because it can be used for spying. The tension is still high.
Chinese industrial firms had a drop in earnings growth for the first time in three years during the month of November. I believe the PMI number next week will be dismal. Merchants stocked up on inventory ahead of tariffs and those stockpiles will take months to work off.
The government shutdown is not a major factor and it will drag on for a few more weeks. More than three quarters of the agencies are funded so this is not a widespread shutdown.
The market has suffered major technical damage and this is only a bounce into year-end. Once this move stalls the selling will resume. My target for the upside is SPY $261. That is the 100-week moving average. Yesterday the market bounced off of the 200-week moving average (SPY $234.70) and that looks like a solid support level.
Swing traders should wait patiently in cash. I believe the market will move higher this morning after support is established. Look for a steady grind higher with follow through the next couple of days. I’m not playing the upside on an overnight basis because the rug could get pulled out at any time. Bullish speculators need to be very careful and they should not try to milk every point out of this bounce. Set targets and take profits. On a swing basis we will wait for this move to run out of gas and we will short the market.
Day traders should wait for support to be established this morning. Focus on the long side and get more aggressive if the SPY is above its first hour high. Tread cautiously in the last hour of trading. That is when we have seen heavy selling. If that pattern reverses (late day buying) it will be a sign that this bounce still has room.
This is only a bounce. Nimble traders should focus on the long side through year-end. Investors should wait patiently for a shorting opportunity.
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