The Independent Market Observer

4/11/14 – It’s a Fender Bender, Not a Crash

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Apr 11, 2014 2:00:00 PM

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For some reason, we are experiencing a new wave of doom and gloom. In the past week, I’ve been forwarded several e-mails rehashing end-of-the-world stories, including an invitation to watch a video entitled Meltdown America. When I was interviewed on TV yesterday, the clear theme of the questions was whether this was it, the big crash.

Yesterday was tough, no doubt about it. But get a grip, folks. After yesterday’s loss, we’re all the way down to the levels of—hold onto your hats—mid-February. Over the past year, we have lost . . . well, no, we’ve actually gained more than 14 percent. Our losses from the peak are a whopping 3 percent or so.

If this is the big one, I have to say it’s not nearly as bad as I thought it would be.

Let’s take a look at what’s actually happening, versus what seems to be the general narrative. Biotech and Internet stocks got overvalued and are now correcting, with consequent declines in the Nasdaq. The fact that they are correcting, rather than continuing to inflate, is actually a sign of market health. Corrections prevent bubbles from forming. The same can be said for the poor performance of some recent IPOs. If they were overpriced, they should trade down; this shows the market is doing its job. Speculative stocks—like small-growth biotech and Internet companies—do go up and down by more. This is a normal market.

The broader market has also dropped a bit, but again, this is normal volatility. Given the rising uncertainty around Russia, Europe, China, and U.S. earnings, I can make a good argument that stocks should, and may yet, correct more—maybe a lot more. While uncomfortable in the short run, this will be beneficial over the long term.

What would a larger correction look like? Jim McAllister, Commonwealth’s lead equity analyst, made the following observations this morning:

There are two remaining levels of support to watch in the coming days. The first is the 100-day moving average, which has proven to be a very strong support level on its own. That strength has been magnified when it has been at the same level as the low end of the trading channel. The 100-day is at 1,830 (pre-market suggests we will be testing this out of the gate today). A break below the 100-day will probably push a test of the low end of the channel, which sits at 1,805 today. 1,800 holds support just because it is a round number. I wouldn’t be surprised if this is where the battleground is established if we get technical selling or selling based on earnings releases or revisions in the coming days/weeks.

We’ve slipped below the lower end of the channel before, but those breaks have been short lived. So a one-day break doesn’t immediately signal another leg lower. Over the past year, it has proven to be more prudent to take a multi-day approach and watch behavior closely when the break takes place. Volume has been very strong the last few days, which would increase the conviction level of any technical action.

IF the lower end of the channel is broken over a multi-day period, the next level of major support is likely the 200-day moving average at 1,770. If we were to reach those levels, it would be a 7-percent pullback from the recent intraday highs (1,897).

Looking at the market so far today, Jim’s thoughts seem to be playing out for the most part. Based on my own research, I start to get worried as we approach the 200-day moving average, but we’re not even close yet.

Make no mistake, we could end up with a much larger correction. The time to get seriously worried, though, isn’t here yet. We will continue to keep an eye on the market, but barring some external event—a Russian invasion of Ukraine, say—the situation still looks to be well within the normal range. As I said the other day, I’m leaning more toward the cautious end of cautious optimism, but the optimism is still there.

This, too, will very probably pass.

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