There was a stock market correction on Wednesday following a mini rally that drove some impressive upward gains in four of five sessions. I feel there is too much relaxation in the market, with traders ignoring the higher stock market risk.
Stocks dove on more uncertainties in Europe, specifically with the European debt issue continuing to drive the hourly trading here on the higher stock market risk.
We have discussed the financial mess in Greece. Now there is heightened concern about who will lead Italy after the pending resignation of Italian Prime Minister Silvio Berlusconi. Consider the fact that the yields on the 10-year Italian bond have surged to over seven percent. This may foreshadow more bad news to come. The speculation is that, when bond yields in the Greece, Portugal, and Ireland 10-year bonds surpassed seven percent; a bailout was triggered, as these countries did not have the ability and means to pay high yields. So now Italy appears to be in trouble, but I have talked about this quite often in my commentaries.
You need to be aware of the stock market risk at this stage. Yes, the recent upward moves in stocks were encouraging for the bulls, but you need to have your guard up.
The fact is that we have had an average earnings season and the debt situation in Europe remains problematic with Greece and the other PIGS countries. There are also domestic issues, namely jobs, housing, deficit, and the economic renewal, which add to the stock market risk.
I have talked about the technical analysis of the charts and the fact that a bearish death cross was still in place, despite the recent five-week rally. I’m cautious, as the trading volume has been relatively light on the four recent up days, which suggests a bearish divergence between price and volume. A death cross is when the 50-day moving average (MA) is below the 200-day MA, indicating high stock market risk.
While the key stock indices are holding at the 50-day MA, the DOW, S&P 500, and NASDAQ broke back below their respective 200-day MAs last Wednesday. With the decline, the S&P 500 fell back into the red for the year, while the NASDAQ is just barely holding on.
The key now is to be aware of the stock market risk.
I have suggested taking some profits off the table during the recent rally. At this stage, you should ride the gains, unless we see a chart reversal; but also make sure that you use put options or buy short-based ETFs as a hedge against the stock market risk.
Just take a look at the various indices that closely reflect your holdings or put options on individual stocks that you have a large position in. Index Puts include the SPY (S&P 500), QQQ (NASDAQ), and IWM (Russell 2000). You can play an aggressive downward slide in technology via the Direxion Technology Bear 3X (TYP).
Be careful given the stock market risk and remember that maintaining your capital will allow you to trade longer-term.
Gold remains a favorite area of mine given the added risk, which you can read about in That Gold Chart’s No Fluke.
I continue to avoid European markets for obvious reasons (see A European Recession: Will There Be One?).