The Market Takes Another Body Blow

Pick your favorite fight movie, because they all fit nicely with today's market action. The hero - clearly the underdog - takes a beating and hits the canvas several times before he finds the will to get up one last time and slay the bigger, stronger, and faster boxer. 

But this isn't a boxing movie. This is real, and our life savings are at stake. Can this aging bull rise from the canvas one more time and vanquish his enemy? It's possible, but with each body blow that drops it to the canvas, it becomes less and less likely.

It doesn't matter whether you are an optimist (Rocky will prevail) or a pessimist (De Niro is washed up), because the market doesn't care about any of that. The market only cares about one thing - the future growth of corporate earnings.

3rd quarter earnings season is over, and the numbers were strong. But there's a debate going on among analysts who track these things. Can the strength of earnings be sustained? By my reckoning, there are fewer analysts now who answer yes to that question than there were after the last earnings season. 

Does this mean the earnings party is over? No, but we all know that trees don't grow to the sky, and neither do earnings. At some point earnings gains will start to slow, and we will start seeing headlines about the end of the bull market.

In the Grand Scheme, today wasn't that big of a deal. But it wasn't nothing, either. It was a body-blow that this weakened bull can ill-afford. A look at the numbers will give us a sense of context, and possibly take some of the sting out of this bad day.

The chart below shows that the market is now down by 7% from the most recent high water mark. That level of decline is not yet classified as a correction, but just a pullback.

Two weeks ago the market was down by 9.9%, barely escaping the correction label. Where it goes from here is anyone's guess, but today was a bad day for the optimists. We had just completed back-to-back decent weeks, and now those gains are starting to unravel.

Next up is the year-over-year chart of the S&P 500, with markers that show the "Zone of Danger" or for you football fans, the Red Zone. This area between 10% gain and 5% gain from the same day the prior year is famous for calling the end of market rallies.

It's not perfect, because it gives false signals about 20% of the time, but it's one of the indicators I use in my Bear Market Probability Model, published in my monthly newsletter.

Lastly we look at the distance we are from a few key markers. Key markers are sometimes used by market technicians and chartists to represent support and resistance. These markers are arbitrary, and sometimes capricious. But one thing they do offer is a window into the very large technical-analysis camp. 

These devotees have lots of money, and a highly respected technician like Ralph Acampora or Robert Prechter can send them into a buying or selling frenzy at the drop of a hat.

From left to right, we are now down 7% from the last peak. We're down 3.6% from the widely watched 50-day moving average. We're down 3.3% from the 100-day moving average. And we're down 1.3% from the very widely watched 200-day moving average. 

The only marker that still stands is the Support, which I chose as 2,581 on the S&P 500 Index. Why did I choose this? Because that was the low at the end of our last correction in late January-early March of this year. My reasoning is that if we breach that level, the technicians will come out in force arguing for worse things to come.

This article was about fundamentals (earnings), technicals (support levels) and sentiment (optimists vs. pessimists.) Let me be clear that I am not calling for a bear market at this time. But I am calling for increased caution, which may include raising a little more cash in case this correction starts to gain momentum to the downside. 

If that happens, cash will be very useful for picking up cheap stocks with great fundamentals. That's what buy low - sell high is all about.