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Has the Market Bounced? Don't Jump Too Fast

02/19/2018 3:31 pm EST

Focus: STOCKS

Kerry Given, PhD

Founder and Managing Director, Parkwood Capital LLC

Is the correction complete? Is it safe to start to seek bargains in the market?  Don’t jump too fast. The opening Tuesday morning will be critical. This week will be the opportunity for a possible retest of the lows, says Kerry Given, PhD, founder of Parkwood Capital.

The S&P 500 Index (SPX) closed Friday at 2732. I was glad to see the 50-day moving average (dma) broken, but it was just barely broken. SPX ran up to 2754, but then declined to close just seven points above the 50 dma. Tuesday’s open will confirm whether resistance at the 50 dma has really been broken.

The closing low on Feb. 8 at 2581 represents a 10.2% correction from the high of 2873 on Jan. 26. Technical analysts normally categorize corrections as declines around 10%, so this is in the expected ballpark. Friday’s close has recovered about half of the decline.

chart 1
Standard and Poor’s 500 Index (SPX)
Chart courtesy of StockCharts.com

Is the correction complete? Is it safe to start to seek bargains in the market? The price action this week would certainly suggest that conclusion. But don’t jump too fast. The opening Tuesday morning will be critical. This week will be the opportunity for a possible retest of the lows.

Market analysts agree that the economic fundamentals are strong. The earnings announcements for the fourth quarter have been consistently strong. If anything, some analysts are starting to fret that earnings are growing too fast.

Trading volume in the S&P companies dropped below the 50 dma this week as the markets rebounded. The Bollinger bands chart documents the recovery from outside the lower edge of the bands to Friday’s close nearly at the 20 dma in the middle of the bands.

chart 2
Standard and Poors 500 Index (SPX) with Bollinger Bands
Chart courtesy of StockCharts.com

chart 3
Russell 2000 Index (RUT)
Chart courtesy of StockCharts.com

The Russell 2000 Index (RUT) closed Friday at 1544, recovering over half of its 9.1% loss since RUT’s high on Jan. 23. The 200 dma served as the solid support level for the Russell index. It was touched on Feb. 6, and the close two days later was just above the 200 dma. Although the 200 dma was broken intraday on Feb. 9, the close was well above the 200 dma and RUT’s recovery was underway.

The NASDAQ Composite traded similarly to RUT but remained 75 points above the 200 dma at its lowest point intraday on Feb. 9. NASDAQ’s trading volume fell off last week, trading at or below the 50 dma all week. As of Friday, NASDAQ has recovered 76% of its losses.

chart 4
NASDAQ Composite Index
Chart courtesy of StockCharts.com

chart 5
CBOE SPX Volatility Index (VIX)
Chart courtesy of StockCharts.com

The CBOE S&P 500 Volatility Index (VIX), opened the week at 27.3% and closed yesterday at 19.5%. The closing high for VIX during this correction was 37.3% on Monday of the previous week, although VIX hit 50% intraday on Tuesday, Feb. 6.

Friday’s close just under 20% brought VIX back to the 20 dma in the middle of the Bollinger bands. That level of the volatility index certainly isn’t low. We aren’t out of the woods yet. If the market turns to test those lows, we could see VIX spike again before things calm down.

I have summarized some key pull back levels for the S&P 500, Russell 2000 and NASDAQ Composite indices below. The correction appears to be of the order of 10%, assuming we don’t have a retest of those lows.

chart 6

The major U.S. market indices have recovered nicely this past week, all up over 50% from the lows. What about the tendency to retest the lows after a correction?

chart 7
Standard and Poor’s 500 Index (SPX) During Last Correction
Chart courtesy of StockCharts.com

I have displayed SPX during the last severe correction in December, 2015. That correction was initially 10.5%, but the retest about three weeks later took the correction to 12%. It required nearly four months to fully recover. The strength of the recovery last week was significant. That initial bounce back in February 2016 was very weak, about 81 points.

As I write this on Monday morning, the U.S. exchanges are closed. Asian markets rallied overnight, but Europe is flat to slightly down today.

The U.S. markets have established six positive market days since the low on Feb. 8, so I am inclined to think we have seen the worst of this correction. SPX and RUT have recovered about half of those losses at this point, and NASDAQ has recovered about three quarters of the correction loss.

Given the past six positive days, it wouldn’t be surprising to see the markets trade sideways or even pull back modestly Tuesday. The positive to slightly negative price action on global markets overnight and today support that conclusion.

My opinion is that we have seen the worst of this correction. I am beginning to establish new positions. The Apple diagonal spread I entered for our newsletter subscribers is just one example.

But I remain cautious.

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