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The Standard and Poors 500 Index (SPX) closed Friday at 2732. I was glad to see the 50-day moving average (dma) broken, but it was just barely broken. SPX ran up to 2754, but then declined to close just seven points above the 50 dma. Tomorrow’s open will confirm whether resistance at the 50 dma has really been broken. SPX's closing low on 2/8 at 2581 represents a 10.2% correction from the high of 2873 on 1/26. Technical analysts normally categorize corrections as declines around 10%, so this is in the expected ballpark. Friday’s close has recovered about half of the decline.

Is the correction complete? Is it safe to seek bargains in the market? The price action this week would certainly suggest that conclusion. But don’t jump too fast. The opening tomorrow morning will be critical. This week will be the opportunity for a possible retest of the lows. Pull up the price chart for SPX during the last severe correction in December 2015. That correction was initially 10.5%, but the retest about three weeks later took the correction to 12%. It required nearly four months to fully recover. By contrast, the strength of the recovery last week was significant at 50% or more on all major market indices. That initial bounce back in February 2016 was weak, about 81 points or a 37% recovery.

Market analysts agree that the economic fundamentals are strong. The earnings announcements for the fourth quarter have been consistently strong. If anything, some analysts are starting to fret that earnings are growing too fast.

The Russell 2000 Index (RUT) closed Friday at 1544, recovering over half of its 9.1% loss since RUT’s high on 1/23. The 200 dma served as the solid support level for the Russell index. It was touched on 2/6, and the close two days later was just above the 200 dma. Although the 200 dma was broken intraday on 2/9, the close was well above the 200 dma and RUT’s recovery was underway.

The NASDAQ Composite traded similarly to RUT but remained 75 points above the 200 dma at its lowest point intraday on 2/9. NASDAQ’s trading volume fell off this week, trading at or below the 50 dma all week. As of Friday, NASDAQ had recovered 76% of its losses.

The volatility index of the S&P 500, VIX, opened the week at 27.3% and closed yesterday at 19.5%. The closing high for VIX during this correction was 37.3% on Monday of the previous week, although VIX hit 50% intraday on Tuesday, 2/6. Friday’s close just under 20% brought VIX back to the 20 dma in the middle of the Bollinger bands. That level of the volatility index certainly isn’t low. We aren’t out of the woods yet. If the market turns to test those lows, we could see VIX spike again before things calm down.

The U.S. exchanges are closed today. Asian markets rallied overnight, but Europe is flat to slightly down today. The U.S. markets have established six positive market days since the low on February 8th, so I am inclined to think we have seen the worst of this correction. SPX and RUT have recovered about half of those losses at this point, and NASDAQ has recovered about three quarters of the correction loss. Given the past six positive days, it wouldn’t be surprising to see the markets trade sideways or even pull back modestly tomorrow. The positive to slightly negative price action on global markets overnight and today supports that conclusion. My opinion is that we have seen the worst of this correction. I am beginning to establish new positions. The Apple diagonal spread I entered for our trading group is just one example. But I remain cautious.

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The news commonly headlines with the Dow, but SPX is my monitor for the market. 500 stocks are a much better measure of the market’s health than 30 stocks. SPX closed today at 2656, up 36 points, and the VIX declined 3.5 points to close at 25.6% - two reassuring signs.

SPX gapped open higher at the opening this morning and that is a very bullish sign. But we have been whipsawed back and forth by this market for the past several trading sessions. I watched the screen carefully this afternoon, wondering if we would see another rapid sell-off as we approached the close. But we retained most of today's gains into the close.

Another positive in today’s market was the weakness this morning. After a positive open, the market dipped around 10:30 am ET, but SPX did not reach Friday’s close. Then the bulls took control once again and continued to drive the balance of today’s trading session.

Friday’s price action was also a positive sign for this market. SPX broke its 200 dma at 2539 briefly, but then strongly rebounded over 81 points to close at 2620.

Have we reached bottom? That seems to be the question of the past several days. It is early to be sure, but these signs suggest we are close:

1. Friday’s strong recovery after hitting the 200 dma.

2. This morning’s gap up opening.

3. A successful recovery by the bulls this morning.

4. A declining VIX.

I began to collect a series of stock trade candidates today in preparation for putting some cash to work in the next few days. I found 15 stocks that have met two principal criteria: 1) They didn’t decline far during this correction, and 2) They were trading higher today. In one case, the stock is already teasing its high before the correction. I will be selecting trades from this group for Dr. Duke’s Trading Group over the next few days.

 

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Members of my trading group are happy campers today. We entered a spread trade on NFLX yesterday, playing the earnings announcement scheduled after the market closed. We could have closed this morning for a 21% gain, but I rolled the short option out and locked in a very conservative 40% gain that will mature in three weeks. If that trade intrigues you, join us at our next trading group meeting, scheduled for February 8th, at 8 pm CT. Our trading group achieved net gains of 133% in 2017 and 169% in 2016.

Learn More About Dr. Duke's Trading Group

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One of the advantages of being a perennial bear is that eventually you get to say, “I told you so”. This incredibly strong bull market was overdue for a minor pause and I believe that is all we are seeing at this point. The Standard and Poors 500 Index (SPX) hit its recent all-time high on January 26th at 2873. Friday’s close at 2762 represented a decline of 3.9%. The next obvious support level would be the 
50-day moving average (dma) at 2715. That would be a 5.5% decline. Many technical analysts look for minor pull backs in the 5 to 7% area and refer to corrections as declines in excess of 10%.

What triggered last week’s pull back? The most common answer cited by analysts was the FOMC announcement that suggested more interest rate increases were coming this year. That should not have been a surprise and one or two modest interest rate hikes will still leave us at historically low levels of interest.

We are in the middle of the earnings announcements for the fourth quarter of 2017 and those announcements have been generally exceeding analysts’ estimates. The effects of the recent tax law changes are only beginning to percolate through the economy. Just consider one of many examples: Apple’s announcement of investing 350 billion dollars into the U.S. economy has not yet resulted in any construction expenditures or new jobs. But it will. My point is simple. The economic foundations are strong. A minor pull back in a strong bull market is perfectly normal. There is no reason to panic.

Trading volume in the S&P companies was above the 50 dma all week as large institutions adjusted their portfolios in the face of the pull back. Many traders are locking in recent gains. When we draw the Bollinger bands on the S&P 500 chart, we see another clue as to where this pull back ends. The lower edge of the Bollinger bands is at 2725, or down 5.2% from the high on January 26th. That 5% number is coming up frequently.

The Russell 2000 Index (RUT) closed Friday at 1547, down 64 points or 4.1% from its recent high of 1611 on January 23rd. RUT has traded much more conservatively for the past month so one might expect less of a pullback in this index. RUT broke its 50 dma at 1553 today.

The NASDAQ Composite has traded strongly in January, matching the trajectory of the S&P 500 index. Similar to SPX, trading volume in NASDAQ exceeded the 50-day moving average (dma) all week. NASDAQ closed Friday at 7241, down 3.5% from its closing high on January 26th of 7506. NASDAQ’s 50 dma stands at 7068, or down 5.8% from the 1/26 high – another number around 5%.

The volatility index of the S&P 500, VIX, closed Friday at 17.3% after opening the week at 11.7%. This remains a relatively low level of volatility. We hit 17.3% intraday on August 11th last year. I am certainly not suggesting you ignore this increase in volatility, but pull backs and corrections normally display levels of 25% or higher. Friday’s VIX, at 17.3%, was higher than any VIX number from 2017, but that was a record year for low volatility. In 2016, we hit highs of 23% in November, 26% in July, and hit 29% twice, once in January and once in February. VIX is a very good warning signal, and we should pay attention, but the current levels are far from correction territory.

My clients routinely have trailing stops and contingent stops on all stock and option positions, and Friday’s price actions certainly tripped several of those stops. But I don’t think wholesale moves to cash are warranted as yet. Monday’s price action will be a critical sign. I am inclined to think the weekend will give traders time to reflect on the market fundamentals and reduce some of the interest rate hike concern.

If we are looking at a pull back of the order of 5%, we may be close, and the 50 dma lines may be expected support levels, at least for SPX and NASDAQ. If we break the 50 dma on SPX this week, I will be making some serious moves to cash my portfolio. But I don’t expect that to be the case. The bulls just need a breather.

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It is interesting that passage of the tax bill near the end of the year resulted in a flat, sideways market. It seemed as though the tax cuts were already priced into the major market indices. But something happened over the holidays. The champagne must have still been flowing Tuesday morning as the market opened in the new year. The Standard and Poors 500 Index (SPX) jumped out of the gate and accelerated every day this week, closing today at 2743, up 19 points. SPX gapped open higher at each opening this week. I have never seen anything like it.

Trading volume in the S&P companies was above the 50-day moving average (dma) Wednesday and Thursday, but fell off slightly today. The price action this week was classic strong bullish behavior: gap opening higher, a market unfazed by any negative news, and strong above average trading volume.

I keep thinking this market has to take a breather at least, if not correct, but it keeps surprising me with its strength. Shorting this market is a fool’s errand.

The Russell 2000 Index (RUT) closed today at $1560, a new closing all-time high. RUT is the only major market index that has been trading somewhat more restrained. SPX and the NASDAQ have been setting new highs almost every day. All three indices closed at all-time highs today – think about that for a minute.

The NASDAQ Composite has also been gapping open higher all week, setting new all-time highs. NASDAQ closed at 7137, up nearly three percent in this four-day week! Trading volume in the NASDAQ composite companies ran parallel to SPX, peaking Wednesday and coming down slowly towards week’s end.

Market volatility, as measured by the S&P 500 volatility index, VIX, set new record lows this week, hitting levels below 9% intraday and closing as low as 9.2% yesterday and today. These record lows in volatility tell us that the large institutional traders don’t see much on the horizon to worry them. Of course, we have been seeing low levels of volatility for most of 2017. In fact, many gurus have pointed to that as an precursor of impending doom and gloom. It does seem reasonable to expect some slowing of this bull market. In fact, I would consider that a healthy sign. But we will have to allow some time for the euphoria of the corporate tax reduction to sink in.

I found it interesting that the FOMC minutes that came out this week showed that the committee members were increasing their GDP forecasts even before the tax bill passed. Remember all of the naysayers who said lowering corporate tax rates wouldn’t do anything for economic growth? Apparently the economists on the FOMC haven’t drank the political Kool-Aid.

Hard economic data continue to be at least moderately positive, with some measures coming in very strong, e.g., Chicago PMI at the highest level since March 2011. The corporate earnings reporting cycle has begun and the large banks are scheduled to report next Friday. Analysts will be watching those bank reports, and especially their forward guidance, very carefully. Presuming the majority of the corporate earnings announcements continue to show positive growth and optimistic future guidance, we may safely assume a continuation of this bull market. But that statement worries me…