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Overbought Sell-Off Strikes With a Vengeance...

10/18/2011 8:54:19 AM

The foreseen correction has begun...

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Stock Market Trends:

Stock Market Trends

- ETF Positions indicated as Green are Long ETF positions and those indicated as Red are short positions.

- The State of the stock market is used to determine how you should trade. A trending market can ignore support and resistance levels and maintain its direction longer than most traders think it will.

- The BIAS is used to determine how aggressive or defensive you should be with an ETF position. If the BIAS is Bullish but the stock market is in a Trading state, you might enter a short trade to take advantage of a reversal off of resistance. The BIAS tells you to exit that ETF trade on "weaker" signals than you might otherwise trade on as the stock market is predisposed to move in the direction of BIAS.

- At Risk is generally neutral represented by "-". When it is "Bullish" or "Bearish" it warns of a potential change in the BIAS.

- The Moving Averages are noted as they are important signposts used by the Chartists community in determining the relative health of the markets.

Best ETFs to buy now (current positions):
Long DIA at $107.72
Long QQQ at $52.07
Long SPY at $112.34

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Value Portfolio:

Daily Trading Action

The major index ETFs opened lower and then began to move lower. That move continued through the day interrupted with a rally attempt in late morning that failed before noon and another with a bit more than one hour remaining in the session. That final rally attempt failed with a heavy volume sell-off in the final fifteen minutes which forced the Dow and S&P-500 to close near their lows logging losses of around two percent. The NASDAQ-100 faired a bit better but still suffered a loss of 1.5%. All equity indexes are back in trading states. The semiconductor index (SOX 370.31 -10.55) plummeted -2.8%. The Russell-2000 (IWM 68.98 -2.16) was rocked for a three percent loss. The Dow Jones Transport Index (IYT 81.79 -2.23) dropped -2.7%. The Regional Bank Index (KRE 20.63 -0.91) dropped -4.2% to close even with its 50-Day Moving Average (DMA). The Bank Index (KBE 18.17 -0.74) closed back below its 50-DMA losing -3.9%. The Finance Sector ETF (XLF 12.21 -0.39) fell -3.1%. Long term bonds (TLT 115.92 +1.97) rose +1.7%. It is in a trading state. The BIAS of all equity indexes we regularly monitor is BEARISH but all have warned of a potential move to a BULLISH BIAS. The BIAS of longer term bonds is BULLISH but has warned of a potential move to a BEARISH BIAS. NYSE volume came in light with 905M shares traded. NASDAQ volume was also light with 1.510B shares traded.

There were three economic reports released:

  • NY Empire Manufacturing Index (Oct) came in at -8.48 versus an expected -4.0
  • Industrial Production (Sep) came in at +0.2% as expected
  • Capacity Utilization (Sep) came in at 77.4% versus an expected 77.5%

The first report was released an hour before the open. The other two reports were released fifteen minutes before the opening bell. The first one certainly affected trading as it is the fifth month in a row showing economic contraction.

The U.S. dollar rose two thirds of one percent to close back above its 200-DMA.

Europe was once again the focus as first the German finance minister and then German Chancellor Angela Merkel commented that the reaction to recent progress made to shore up European sovereign debt was too optimistic and that more needed to be done. This caused European bourses to falter and when U.S. markets opened, the rapid rise seen in the last two weeks began to be picked apart as market participants took the opportunity to take profits and bears began to add to short positions once again.

All ten economic sectors moved lower led by Financials -3.3%. In order of severity the rest were Materials -3.1%, Industrials -2.7%, Consumer Discretionary -1.9%, Tech -1.8%, Energy -1.7%, Health Care -1.7%, Consumer Staples -0.9%, Telecom -0.7%, with Utilities -0.3% losing the least.

The yield for the 10-year note fell eight basis points to close at 2.15. The price of the near term futures contract for a barrel of crude oil fell forty-two cents to close at $86.38.

Implied volatility for the S&P-500 (VIX 28.24 -2.46) fell eight percent. The implied volatility for the NASDAQ-100 (VXN 28.69 -1.61) dropped five percent. Implied volatility broke below the low end of its range since early August. We thought it would likely bounce but it appears that option writers believe that there will be less volatility going forward.

Market internals were negative with decliners leading advancers 7:2 on the NYSE and by 9:2 on the NASDAQ. Down volume led up volume 7:1 on the NYSE and by 5:1 on the NASDAQ. The index put/call ratio rose 0.24 to close at 1.60. The equity put/call ratio rose +0.11 to close at 0.71.


Monday was another light volume trading day, albeit a bit heavier than seen last Friday. We saw the high probability pull-back take shape on Monday with all three major indexes in overbought territory (our proprietary scale).

There were several catalysts listed in order of severity:

  • The main cause was renewed fears over a potential global financial system meltdown. Of course, these fears have been on again, off again for some time with the "risk on", "risk off" trades coming en masse.
  • The Empire State Manufacturing Index continues to show contraction and was markedly worse than expected. With a grinding higher economy expected, the continued set-backs of contraction in New York are weighing on the minds of bulls who are expecting a push into a mildly expanding economy.
  • Earnings reports have been worse than expected for the countries large banks and other companies that reported earnings have failed to impress, with notable exceptions such as Google (GOOG 582.41 -9.27). Citigroup (C 27.93 -0.47) actually reported better than expected earnings and gapped higher on the open but it closed lower in sympathy with a sell-off in the Financial Sector (-3.3%).

In reality, we believe that U.S. equities were poised for an overbought sell-off due to the rapid rise over the prior two weeks. Now that this has occurred, it is a matter of how the leading indexes react to the sell-off. If investors continue to embrace Tech (-1.8%), then the market can still continue to climb. Tuesday's reaction will be critical to our perspective and whether we will remain in our current long positions.

We hope you have enjoyed this edition of the McMillan portfolio. You may send comments to mark@stockbarometer.com.


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