Markets are searching for a bottom. It was the worst one-day decline within a year last Thursday, after massive selling drove the key stock indices to below their respective 200-day moving averages (MA), a bearish sign. The DOW fell 376 points or 3.6% and came within 42 points of breaching 10,000, which I feel will be broken and probably has been by the time you read this. The DOW broke below its key 200-day MA of 10,253.
The selling is broadly based, with technology attracting the brunt of the selling, as the NASDAQ breached its 200-day MA of 2,220. The S&P 500 is also below its 200-day MA of 1,102. The Russell 2000 is just holding above its 200-day MA of 628. Market volatility is surging, with the VIX over 45. Markets are searching for a bottom or base and are vulnerable to additional losses. Markets are negative on the year and could be heading lower.
The selling capitulation appears to be picking up. The near-term technical signals are bearish on negative breadth. Relative Strength continues to weaken and remains below average, so there could be more downside moves as the indices look for a base. Sentiment on the NYSE and NASDAQ turned bearish last Thursday. Markets are in a correction phase, with the decline from the recent highs between 10% and 14%. Failure to hold could mark a trend reversal on the charts.
Clearly, the current market is dangerous, and has been for weeks. There was a bearish double top on the DOW a few weeks back and it has played out. The weakening Relative Strength points to an extremely fragile market that is sensitive to negative market news.
Driving the nervous bias has largely been the increased concern towards the conditions in Europe along with a potential asset bubble in China that is leading to tighter loans and possible higher interest rates. The euro continues to fall against the USD and is at a four-year low on fears that the austerity measures in Europe could slow down economic growth in the region.
The situation in China continues to be a concern. The Shanghai Composite Index (SCI) is near its lowest level in a year, as there continue to be concerns about overheating and higher interest rates in China. The SCI is in a technical bear market, down 21% in 2010 and struggling to hold. You need to be very careful with U.S.-listed Chinese stocks, as the market risk is extremely high at this juncture.
In all, the current market risk remains extremely high. I feel that there is a vulnerability to selling and want to see if markets can find a bottom or base. This is not a market climate to be a hero. Remain prudent and let’s see if markets can find some buying support and positive news. Initiating Put options to hedge against the downside risk, as I suggested recently, makes sense.
The key for you is capital preservation, which will allow you to have funds available at a later time for buying opportunities.