The market has put together a very robust bounce in recent weeks, as worries about a China trade deal and a hawkish Fed have been alleviated. Sentiment was extremely negative and many stocks were grossly oversold, as the indices hit the lows of the year on December 24.
Since then, there has been a better than 10% bounce in the indices and the mood has improved significantly. There is now hope that stocks will continue to run as earnings season begins this week, with several large banks and Netflix (NFLX) issuing their reports.
However, much of the market is now technically extended and needs some rest. Many market players have been fearful of missing out on further gains, but they are looking now for some justification in recent profits.
It is important to recognize that the technical conditions of the market tend to drive the way news is perceived, rather than the other way around. When the indices are oversold, like they were on Christmas Eve, there is a greater tendency to look for a positive spin on news. When the indices are overbought, like they are now, there is a stronger tendency to look for negative news to justify some selling. Finding negatives right now is not hard.
The government shutdown hasn't bothered the market at all recently, but there are now headlines that the economic impact is about to be felt and there is concern that it is going to start showing up in some of the macro numbers. The shutdown has been viewed as just a political distraction by the market, but there doesn't seem to be any progress on a solution -- and that uncertainty is causing some concern.
There is also news about continued economic weakness in China. The earnings warning from Apple (AAPL) already highlighted some problems, but Sunday night, it was announced that China's exports fell the most in two years in December, while imports also dropped. Not only is there weakening global demand for Chinese goods, but the trade surplus with the U.S. expanded over 11% in the past year. There couldn't be a worse combination of economic factors for China, and it makes the stakes in the trade negotiations with the U.S. even higher. We have to wonder if the weakness in China can stay isolated and not have an impact around the world.
In addition to China, Europe is facing some issues -- as the Brexit vote is likely to fail in the UK on Tuesday, the ruling coalition in Greece is crumbling and business optimism is contracting.
Oil, which has been helping to drive the recent rally, is reversing this morning and is trading down 1.7% and there are headlines stating that U.S. investors are worried about upcoming earnings from the major banks.
With technical conditions already difficult, the negative news makes it easier to justify some selling. The headlines to explain a market pullback write themselves. The market is extended and can use some consolidation, but the big question is how quickly the indices will find support. Some bears are predicting a retest of the December 24 lows, but that is a very significant drop and is unlikely to happen quickly unless there is some very surprising negative news.
The technical conditions are telling us that negative news may now matter. Stay cautious.