Time to Buy

 | Aug 02, 2012 | 5:30 PM EDT  | Comments
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In Wednesday morning's better-late-than-never column, I cited the filling of the May 4 gap in the S&P 500 at 1391.57 as the best reason -- maybe the only reason -- that the market stalled at that level Monday morning, topping out at 1391.74, and then turned south. A few days later, the S&P 500 is 36 points lower. The Dow Jones Industrial Average has collapsed 350 points from Monday's high. The Russell 2000 has sold off to within a fraction of a point of last week's multi-week low.

I also noted that the top of the May 4 gap was the ideal spot to sell. I used the return to new multi-month highs in the S&P 500 to lighten up further in that sector. At that point, cut back to a maximum of 45% invested. But as the market erases all of last Friday's sharp pop, there are compelling opportunities on the long side again -- at least that's what it looks like from here.

In a way, today's selloff is kind of the reverse of Monday's pop to new multi-month highs.  On Monday, it was the S&P 500 and Dow that scored new multi-month highs. The Russell 2000 and Nasdaq failed to confirm those highs. So, on Monday the broader market underperformed the blue chips. Today, at least on a very short-term basis, it's the converse. The broader market is holding up a bit better than the blue chips.

You can probably see this most clearly by looking at the Nasdaq, which is currently off 23 points, or a little less than 1%, while the Dow and S&P 500 are off 1.24% and 1.32% respectively.

Though you can't see the intraday performance on the chart below, it's also noteworthy that the Nasdaq made its low in the first few minutes of trading and while the Dow and S&P 500 sold off well below the morning lows, Nasdaq is still holding above its morning low. Also noteworthy is that on the morning bounce off the early lows, the Nasdaq completely filled its opening gap and turned positive on the session. The Dow and S&P 500 failed to do so.

In the Nasdaq, it's also probably no coincidence that the low of 2890.85 is only about 2 points below last Friday's gap. So, for now, that now-filled gap marks the low.

Nasdaq: Bouncing off of last Friday's gap.
Source: optionsXpress

A similar story is behind the Russell 2000. You may recall that earlier in the week the RUT failed to fill its July 20 gap at the 802 level and turned back down. That also warned of trouble ahead. This morning, something a little more positive happened. The early low in the RUT held just above last week's low of 765.05. From there, the Russell popped back up, filled its opening gap, and briefly turned positive before selling off to a slightly lower low. But that lower low of 765.20 still held just pennies above last week's low. Again, while the Dow and S&P 500 are getting hammered and dropping to lower lows late in the day, the RUT is still holding at or near the morning lows.

Russell 2000: Double bottom at last week's lows.
Source: optionsXpress

This broader market outperformance is bullish in my book, so, for mutual fund accounts (where I am currently holding long in a range of 25% to 50% levels), I am adding to long positions at the close. For option accounts, I have been writing distant iShares Russell 2000 Index (IWM) puts and buying SPDR S&P 500 (SPY) calls during today's selloff.

The story of the S&P 500 is inconclusive if only because the July 27 gap at the 1360 level has been exceeded by a good margin (about 5 points) and now, beckoning below is the July 26 gap way down at the 1337 level. Maybe we have to see that level before this shakeout is complete. That keeps me a bit circumspect at current levels.

S&P 500: No longer the relative strength leader.
Source: optionsXpress

On the positive side, the market should be heading toward an oversold reading again and that's bullish for the near term.  The McClellan Oscillator settled Wednesday at the -51.8 level on the oversold side of neutral.  A close anywhere near the lows should lead to an oversold reading (below -100).

But then there is bearish sentiment, which is not heating up much as the market sells off and that bugs me. The Volatility Index (VIX) is actually down a bit at the  18.25 level with the Dow down triple digits. That's not a good sign as it reflects too much complacency.  Of course, I am long December VIX (24) puts so I can't complain.

VIX: Not reflecting much panic.
Source: optionsXpress

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