What do they say?
Commentary: After a brutal decline in early August, the stock market has spent the rest of the month attempting to stabilize. Volatility has been decreasing slightly, although the markets have been exposed to some violent swings in both directions. The initial bounce after the initial August lows was very sharp which is typical with such oversold conditions. However, the bounce only lasted a few days before a reversal took the markets back towards its lows. With the markets now finding support at these levels, the question becomes whether a low is forming or simply a pause before the next decline.
The S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY) has been able to stay above its early August lows as buyers stepped in near $112.50 on the last pullback. While that is a slight positive, SPY remains well below its prior base. It takes time to repair damage the magnitude of what SPY has suffered, so traders should not expect a straight line rally to new highs. SPY has struggled to just stabilize and still has plenty of resistance above. The first level traders should keep an eye on is $121 to see if SPY can attempt a rally to the bottom of its prior base. If SPY can clear that level, it could make a run towards $125-$127. Otherwise, SPY would likely head towards the bottom of its range, or worse, new lows.
The Diamonds Trust, Series 1 (NYSE:DIA) ETF has also been trying to stabilize after the declines earlier this month. DIA did come back to the bottom of its base though, before reversing in an ugly gap down. This level remains an important area to watch, but also the $118 level just a few points higher bears watching as well. This is where the 200-day moving average is currently situated, but also corresponds with an important low set in June. Sellers are likely to step in around this area, so traders should be careful if DIA continues to bounce off its recent lows. (For more, see The Anatomy of Trading Breakouts.)
The biggest news this week in the markets not related to Jackson Hole was the stepping down of Steve Jobs as CEO of Apple, Inc. (Nasdaq:AAPL). While it certainly can’t be described as unexpected, the reaction in the stock was notable. AAPL gapped down $11 before reversing to close near unchanged. It then rallied hard the next day closing higher by almost 10%. Why is this important? As the largest component in the Powershares QQQ ETF (Nasdaq:QQQ) ETF, it was a large reason as to why QQQ outperformed the general indexes to close out the week. This is healthy behavior, as one would look to QQQ for market leadership. QQQ is currently testing its declining 20-day moving average and could push back into its prior base with only a little more strength. This would be a positive for the entire markets. (For more, see Trading The QQQ With In-The-Money Put Spreads.)
The smallcaps though, as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF continue to notably lag the markets. IWM remains well below its prior base and still has room before testing its 20-day moving average as well. This index would typically be stronger during a healthy market period, so astute traders should make note of the relative weakness. The key levels to watch over the next week are $64 and $72. This is the range that has been established over the past few weeks and until IWM breaks in either direction, it could remain choppy.
The price action this week was positive in that it helped stabilize the recent weakness. The markets are at least groping for a bottom to the decline that began a few weeks ago. However, traders should realize that the environment is still very dangerous. While some individual stocks are starting to look better, the vast majority of stocks are still trading below their 50-day moving averages. In fact, over 95% of stocks are below this important measure. This is revealing a market that is still unhealthy and thus fraught with risk. There is a small chance that the markets are trying to form an important bottom, but it is also likely that the markets are simply pausing after such a steep decline before pressing lower. Until we see how the markets react to resistance above, it will be hard to guess which scenario is next.