Despite the very negative headlines about the potential impact of the coronavirus, market participants have tried to shrug off the concerns, and have been able to bounce the S&P 500 all the way back to the levels that were hit on Friday, January 24.
At first, the technically inclined were calling it a dead cat bounce, but good earnings reports from Apple (AAPL) and several others gave the bulls some ammunition, and there was a willingness to believe that the coronavirus spread may not be as bad as feared.
On Thursday morning, there are more good earnings from Microsoft (MSFT) and Tesla (TSLA) , as well as a dovish Fed, but the market is now starting to understand that there is inevitable economic fallout from the virus, even if it may not be as virulent as originally feared. There are estimates that the virus could decrease China GDP by 1% to 5%.
Asian markets were down sharply overnight and U.S. markets are gapping down. The S&P 500 looks like it is in position to test the levels hit on Monday morning.
This on-and-off fear of the coronavirus is making the navigation of the market action particularly difficult. It is likely that is caused in large part by program trading that is enhancing the bounces and causing sentiment to shift. The only reasonable explanation when there is a big bounce like on Tuesday is that maybe the virus isn't that bad.
Another challenge for traders right now is that the strength in this market has been quite narrow. A few big caps like Apple and Microsoft have done much of the heavy lifting. If you look under the surface of the action, the percentage of stocks that are over their 200-day simple moving average has dropped sharply in the past eight days -- going from 63% to 55%. This is largely a function of small-caps (IWM) , which are lagging and are set to breach their 200-day simple moving average.
There have been some stellar big-cap earnings reports, but most of these names are very extended and it is tough to justify chasing them higher unless you are a computer algorithm with extremely short timeframes.
Many of the major earnings reports are now over, the Fed has spoken and nothing new will be happening there, and seasonality turns negative. The conditions for a pullback are good, but as we've seen in the past week, there is still great resistance to embracing the negative narrative.
If the lows hit on Monday are reached, that is going to produce some downside momentum, but what will really change the character of the action is a weak close.
There is a good reason for caution, but one bright note is that there are many secondary stocks with healthy technical patterns. Whether they can rally when the bigger-cap names correct is the issue.
My game plan is to focus more on some index shorts while doing some selective stock picking. The bears are in position to do some damage here, but their ability to follow through is suspect.