Goldman throwing sand in the wheels?

The markets were jolted this week as news came out on Friday that the SEC was filing a civil suit charging Goldman Sachs Group (NYSE:GS) with fraud for withholding “vital information” on a subprime mortgage product. To compound matters, the news was released on an options expiration day, which probably magnified the market’s increased volatility. Financials took a big hit with the Financial Select Sector SPDR (NYSE:XLF) shedding approximately 4%.

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The S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY), was the index hardest hit on Friday, surely due to a greater exposure to the financials. SPY almost reached its 20-day moving average in one day on a large increase in volume. While increased volume can be a byproduct of options expiration, in this case it was more likely in response to the uncertainty surrounding the GS news. The markets react most violently when they are surprised, and this news certainly came from left field.

In looking at the chart structure for SPY, the uptrend remains intact overall, but this high-volume distribution day should not be ignored. Last week we mentioned some divergences appearing in the markets, showing a decrease in momentum; with another high-volume selling day this week, the possibility of further selling is very real. The rising 20-day moving average would be the first level to watch on continued weakness next week, with the prior base near $115 serving as primary support if selling really accelerates.

Source: StockCharts.com

The Diamonds Trust, Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, also experienced some urgent selling on Friday although much like SPY, there was not any technical damage to the structure of the uptrend. DIA found some buyers as it dipped toward the $109 level and is still above rising its 20- and 50-day moving averages. The high volume selling day does serve as a warning however, especially when combined with divergences in technical indicators that reveal waning momentum. There are a few levels to watch on further weakness such as the 20-day moving average, but ultimately, the prior breakout area near $107 would be classified as primary support.

Source: StockCharts.com

The Russell 2000, as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF, also had a weak Friday, but actually held on to close the week solidly in the green. It’s still well above its rising 20-day moving average and the small consolidation it formed after breaking out in February. If you disregard the news and simply look at this chart, there are no signs of a top in place yet. There is a high-volume selling day that could turn into a reversal, but in reality only two days’ worth of gains were erased in IWM. It’s possible that IWM will pull back into its rising 20-day moving average over the next week, but even this would not necessarily signal anything more than profit taking. The levels to watch moving forward are the past two breakout levels at $69 and $65.

Source: StockCharts.com

The chart for the Powershares QQQ ETF (Nasdaq:QQQQ) also managed to close the week in the green despite a weak Friday. Much like IWM, QQQQ remains well above its prior base and is in a healthy uptrend. The $47 level will be an area to watch if the selling really picks up, but more likely, buyers will step in near $49 and $48 as QQQQ pulls back into its rising 20-day moving average and a small congestion area. The high-water mark for now is $50, and a move above this level would probably negate any notion of a top.

Source: StockCharts.com

Bottom Line
If you simply disregard the news and look at the chart, the end result is another high-volume distribution day added to the mix. It’s always disconcerting to investors when a high-volume distribution day occurs, but typically this type of quick sell-off helps temper enthusiasm and ends up being healthy overall. How the markets respond over the next few days will be much more important in terms of gauging the strength of current market participants. The markets have avoided a pullback for several weeks, and ultimately they will correct. We won’t know until we are well within the pullback that it is occurring, so traders need to adhere to their trading plans and stop levels. The markets will let us know soon enough whether a top is forming, but for now the high volume distribution day is simply that: one negative day in what has been a very impressive rally.  

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