Via FBN Securities' Chief Market Strategist Jeremy Klein,
As someone who steadfastly held onto a bullish outlook, I desperately hoped that volatility would remain contained as the various sentiment metrics that I track, such as TICK readings and open interest in the futures, pushed deeper into overbought territory. Trading ranges crept higher last week and have failed to narrow. Although the amount of skittishness is not excessive, it has moved to dangerous grounds to push many of those investors who have feasted on dips over the past five years to the sidelines. Consequently, I am officially switching to an intermediate term bearish outlook this morning.
I assess the fundamental environment as neutral. While extremely transparent monetary policy and estimated robust earnings growth are unambiguously favorable, the forward multiple on the S&P 500 still resides within spitting distance of its upper bound since 1990 save the era of the Dot Com Bubble. Hence, stocks bumped into a ceiling once the blue chip index began flirting with 2,000 as companies have little room for error when announcing their results.
Some macro data points have exhibited definitive signs that the economy has accelerated. However, weakness overseas and a disappointing miss of consensus by the Jobs Report throws into question the optimistic assumptions about the global recovery. Moreover, a relentless rally in the Dollar will crimp profits for multinational corporations. The strength in the Greenback is starting to garner attention from traders. With the Fed ambling toward a path of restrictive measures, this trend in the F/X markets is secular in nature. Nevertheless, the FOMC will almost assuredly delay any decision to pare its balance sheet passively via a cessation of the reinvestment of the proceeds of maturing assets until mid-2015 at the earliest such that any retracement that does arise will be cyclical in nature to offer a fortuitous buying opportunity at its terminus.
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Although the calendar remains largely quiet in the coming days, I envision that the wide price swings will persist. The magnitude of the drop in the wake of the anticipated launch of the “Apple Watch” should have concerned portfolio managers. While the news out of Cupertino only pertained to the tech giant and a handful of other companies related to the product suite, the broader indices were dragged around like a rag doll.
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This sensitivity to headlines reflects an attempt by many firms to salvage performance for 2014 by augmenting their exposure aggressively over the past several weeks. Similar to the countless number of jockeys who have failed in the grueling 1.5 mile Belmont Stakes by asking for their horse to start its kick too far in front of the finish line, these funds moved too soon as year-end still sits far off on the horizon. This incremental positioning grossly inflated the average monthly NYSE closing TICK which extended to +338 on Monday. Thus, the muscle for a protracted selloff is intact.
The pullbacks from January and May 2013 mark the most recent instances of an expansion of volatility concurrent with this critical technical statistic stretching to such lofty heights. I therefore forecast a 7% decline in the S&P 500 from its intraday top printed on September 4 to yield a target of 1870. Since security prices are negatively skewed in that they fall much faster than they rise, the descent will occur rapidly. I project that a bottom will arrive sometime in October but will adjust this thesis if the broader indices refresh their peaks and session ranges again collapse to more palatable levels. While few names will avoid the downward pressure, small capitalization shares and high beta tickers will suffer the most damage.
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S&P 500 Cash Key Technical Levels
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Support: 1984.75, 1977.50, 1974.25, 1969.00, 1965.00, 1955.00, 1941.50, 1938.00
Resistance: 2000.50, 2007.00, 2011.25, 2025.00, 2050.00
Fair Basis to ESU4 (source: Bloomberg): -0.92
