On the evening of January 2, market players were stunned when a drone was used to kill the second-highest ranking official in Iran. There was speculation about an all-out war as the Iranians promised a swift and brutal response. With the indices grossly extended and hitting new all-time highs, it appeared to be a perfect setup for some corrective action in the indices.
The indices did gap-down at the open on Friday, but the softness immediately attracted dip buyers that have anxiously been waiting for the opportunity to buy a pullback. On Monday, there was another gap lower and the dip buyers were even more aggressive at buying the dip this time.
The net impact of the two days of selling pressure following the Iranian news was a loss in the S&P 500 of just 0.36%.
The good news is that this strength illustrates how much buying power there still is in this market. The great fear is missing out on buying opportunities, rather than being caught in a sudden reversal. One of the big reasons this dynamic exists is because of the very accommodative Fed, which is supplying high amounts of liquidity but is not calling it Quantitative Easing this time.
The bad news is that the indices are still technically extended and in need of a rest, as positive seasonality starts to slow. Ideally, the indices and many stocks would pull back and set up favorable technical patterns as we head into fourth-quarter earnings season.
The Iran news was a perfect excuse for some corrective action, but market players stayed too bullish for it to work. There was no great fear in this market and dips were just an excuse to put more cash to work. It leaves the market more prone to sudden fits of volatility, but it also tells us that if a top is going to form, it is very likely to be a process that is going to take some time.
As always, there are legions of market timers trying to guess when a top might form. Iran was an obvious catalyst -- but maybe it was too obvious. Not only was nearly everyone aware that some corrective action was needed, but nearly everyone was anxious to buy it. The folks that were rooting the loudest for some downside were underinvested bulls that were anxious to put capital to work.
There is still the likelihood of some surprise Iran developments that may prevent the indices from gaining significant upside momentum, but market players are very well conditioned now to buy any and all dips. It is going to take a while for that dynamic to shift, no matter what news might hit.
Without a big gap down open to buy Tuesday morning, market players are a bit confused. They aren't inclined to chase strength with the indices still overbought and the potential for surprise news, but cautious buyers have been missing out on some good bounces over the last two trading days and they are concerned that they will continue to be left out if they don't do something.
It is a tricky environment and my game plan is to focus less on the uncertain indices and more on my individual stock holdings. There are some good gains that I want to hold on and I'm still willing to buy good charts. On Monday, for example, I named DataDog (DDOG) as my Stock of the Week and it performed well. The chart is still attractive and I'll be looking for additional entry points as it develops. With a number of charts like this in the market, it is tough to be too bearish, even if the indices are still extended.
We have a flat start to the day and a complacent feel. I suspect if this market is going to sell off that it is likely to start as an intraday reversal rather than a gap lower at the open. The dip buyers are too well-conditioned to not buy morning weakness, but a late-day selloff would catch many by surprise.
