As You Were Not

If you thought this market only goes up, Friday was a painful reminder that things can fall too.  Markets experienced their worst day in about two years with the DJIA falling over 665 points and S&P500 falling over 65 points.

Presumably this move was a result of a cocktail of economic news, the most recent of which was a strong jobs report.  It appears the big-picture concern is the Fed may have to take more significant action and raise interest rates more aggressively if economic data continues to point toward increased inflation.  Apparently this was enough to start the feeding frenzy that was last week — with Friday being the biggest drop we’ve seen in some time.

With the unconstrained bull market officially shaken, what happens next?

First, let’s be clear.  The bull market was not ‘killed’ by one week of activity.  In fact, economic data continues to look strong.  However, as has been discussed in both this blog and in weekly forum calls, the markets were over-bought and the probability for a pull-back was high.  It appears we’re finally seeing some mean reversion as volatility returns.

The sell-off continued over the weekend in the futures markets.  And it’s likely the markets will open with continued negative sentiment.  So what now?

Looking forward, what are the key levels to pay attention to?   First, look for the 2715/2700 level for support on the S&P500.  That is where the 50-day moving average is.  And 2700 is a nice round number.  Below that, 2632 and 2585.

The 2632 level will fluctuate this week as it’s the 100-day moving price average.  The 2585 level is the one to watch.  This is official correction territory for the S&P500.  It also seems to be the area traders may be keying in on after the big January move higher.

Make no mistake, the technical damage on Friday was real.  But this still doesn’t have the underpinnings of a 2008-style event.  Caution is warranted though.  While all three macro indicators remain long, a look under the hood in the BigFoot systems reveals a change in trading signal for all three major indexes from buy to wait.  The database also fell below 70% long for the first time in months (maybe years), falling down to 68.58% long.  This is confirmation that short-term volatility is real – and enough to move the needle in the trading systems.

This week will be important as far as price action is concerned.  Watch for follow-through and an increase in negative sentiment.  If buyers don’t show up soon, we may see the first official 10%-correction we’ve seen in nearly two years.

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