When it rains, it pours. Bad news seems to be erupting from every corner of the market these past few days and investors started off the week with yet another devastating sell-off after S&P downgraded U.S. credit quality to AA+ from its coveted AAA rating. In the press release following the downgrade, S&P stated, “Our lowering of the rating was prompted by our view on the rising public debt burden and our perception of greater policymaking uncertainty, consistent with our criteria. Nevertheless, we view the U.S. federal government’s other economic, external, and monetary credit attributes, which form the basis for the sovereign rating, as broadly unchanged”. Fear across financial markets continues to push gold higher, with December futures contracts hitting $1,723 an ounce mid-day Monday. Crude oil, on the other hand, has been tanking alongside equities and futures prices slid down to almost $80 a barrel yesterday afternoon.
The S&P 500 was on track for a stellar recovery year, gaining close to 9% in the beginning of 2011 prior to topping out in March. SPY, which tracks the S&P 500 Index, has declined by close to 18% since peaking at $137.18 a share on 5/2/2011, reversing its year-to-date performance to negative 10% as of yesterday. Recent selling has put many investors in “panic mode”, ready to pull the trigger and unload positions at the drop of a pin [see Three Defensive ETFs For The S&P Downgrade]. We certainly don’t advise entering the market at current levels simply because “stuff is cheap”, but at the same time investors should reconsider their positions carefully before rushing to sell.
Consider SPY’s daily chart below. The violent sell-offs in the past two weeks have put the market under tremendous pressure and SPY has broken lower, closing below its 200-day moving average (yellow line) for the first time since August of last year. What’s worrisome is the sheer volume behind these sell-offs, simply notice the spike in trading volume during the last 3 days [see SPY Technicals]. From a historical perspective, any time SPY is under its 200-day moving average it is best to steer clear, since the fund may bounce higher unpredictably and then continue to sell-off and make lower lows.
Active traders are likely smiling since the recent volatility has provided for some extraordinary trading opportunities for those with a keen eye and a disciplined approach. In terms of upside, SPY can bounce back to anywhere from $115-$125 a share in the coming months. Likewise, the sheer volume behind these recent sell-offs is quite worrisome and it is best for investors to stay on the sidelines until the dust settles.
Investors should anticipate a rally one of these days since markets have a history of “bouncing back” after such a steep sell-off, only to continue lower in the days following. A strong enough dead-cat-bounce could push SPY near $120 a share. In terms of downside, SPY needs to establish support above $115 a share before it’s even reasonable to consider that the recent sell-off was merely an overexaggerated correction to the longer-term uptrend. If support breaks below the $110 level, it is safe to say that SPY will continue plunging until it nears $100 a share [see ETF Insider: Be Wary Of Bargain Shopping].
Don’t expect a clear buy/sell signal from the markets. If your portfolio includes a sizable allocation to equities it may be wise to take some money off the table. If on the other hand you’re in a (brave) buying mood, remember to buy in small increments so if the price falls further you can continue to average down. Conservative investors should take their time and not rush in or out of positions, this market can and will turn on a dime.
As always, investors of all experience levels are advised to use stop-loss orders and practice disciplined profit taking techniques.
Disclosure: No positions at time of writing.