The stock market took it on the chin again yesterday, but this week’s decline is still only a blip on the radar screen of the long-term picture of the stock market. Yes, volume did pick-up, so that’s a concern….but given the fact that the composite volume was still below 3bn shares, it’s hard to make too much of this development. We’d also note the breadth on the S&P 500 was only 1.7 to 1 negative…so yesterday’s action was a long way from being a disaster.
That said, we definitely saw some material weakness in the small-cap sector of the marketplace…as the Russell 2000 declined just under 2%. The breadth was 4 to 1 negative on that index. That’s not good, but it’s not horrible. However, volume rose by more than 40% (on the IWM Russell 2000 ETF)...so the action in this index certainly raises some concerns.
On a technical basis, the Russell seems to be forming a textbook “Head & Shoulders” pattern…so if it sees further downside follow-through over going forward, it’s going to raise a big red warning flag. The “neck-line” of that “H&S” pattern comes-in at the 2,150 level (212.00 on the IWM). Therefore, we will be watching these levels VERY closely. Any meaningful break below these levels will signal as very compelling change in trend (especially since the Russell has already broken below its trend-line from the early November lows). (First chart below.)
NFLX reported earnings last night…and the stock is trading down by 8%-10%. This is a classic example of why it is essential to wait for important support/resistance levels to be broken before one reacts to the development. The fact that a resistance level BECOMES a resistance level is because it is one that is difficult to break! (The same is obviously true for support levels.) Therefore, the odds are high that the asset in question will roll-over from that resistance level (and bounce off a support level). Therefore, we have said zillions of times in the past, we HAVE to wait for a meaningful break of the resistance level before we can confirm that a recent rally in an asset will turn into a strong one (and the same is true on the downside with support levels).
Given that the decline in NFLX is so severe, its upside potential has been all but wiped-out…at least for the time being. The question is whether this will have a significant impact on the broad Nasdaq Composite Index. As we have highlighted several times recently, whether the Nasdaq can breakout to new all-time highs…or makes a “double-top”…should be VERY important to the tech group AND the broad stock market over the coming days and weeks. Today’s weakness in NFLX is raising the odds that it will become a “double-top,” BUT we have a long way to go before we can draw that conclusion. In fact, it’s still quite close to its February highs, so the odds are still leaning towards the bullish side of the bull/bear ledger. It’s just that the odds are not as strong as they were at the end of last week……Needless to say, we’ll be watching this situation very closely…to see how it unfolds going forward. (Second chart below.)
Finally, we just want to highlight that lumber saw a BIG reversal to the downside yesterday. This is not a big surprise because this commodity had become EXTREMELY overbought on a short-term basis. It’s RSI chart reached 86 on Monday…and every time it has moved into the high 80s over the past two years, it has been followed by a sharp decline in lumber. Therefore, we would not be surprised at all if the decline that began yesterday becomes a strong one.
We’d also note that the RSI charts on Home Depot (HD) and Lowes (LOW) had become extremely overbought early this week as well. The RSI reading moved above 82 on HD…and just below 82 on LOW on Monday. Therefore, these stocks were becoming quite ripe for short-term pull-back anyway…so the reversal in the price of lumber could exacerbate any near-term decline in these two names as well. With this in mind, long-term investors should hold-off from being aggressive on the long side of these two names…and short-term traders can consider some negative bets…at least over the near-term. (3rd, 4th & 5th charts below)
We want to highlight that the technical condition for most other commodities is not anywhere near as extreme as it is for lumber, so this near-term cautious call is NOT one we’re making on the broad commodity asset class.
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Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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