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Dear reader,
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| August 25, 2015
Get on the Defensive Until
Market Shows Signs of Stabilizing
By John Kosar
The U.S. stock market has been threatening a corrective decline for months, and it came to fruition last week with massive selling on Thursday and Friday.
The Nasdaq 100 led the decline, falling 7.4%, but all major indices closed sharply lower for the week and slid into negative territory for 2015. Every sector of the S&P 500 ended in the red, led by energy, down 8.5%, and technology, off 6.7%.
In fact, the only sector to do well recently has been utilities, which lost only 1.1% last week. I first mentioned this group as a potential sector to overweight this quarter in the Aug. 3 Market Outlook. Through Friday's close, utilities had risen by 5.4% over the past month. It was the only sector to post a gain during this period, while outperforming the S&P 500 by a whopping 12.4 percentage points.
Multiple Price Targets Met Last Week
Two of my recent downside targets were hit during last week's collapse. The London FTSE 100 fell through the 6,550 level first mentioned in the June 8 Market Outlook. And the sell-off in the small-cap Russell 2000 took it through the 1,175 level, which I pointed to in the July 27 report.
In addition, just before last week's decline began, my two upside targets in the housing sector were also met. The PHLX Housing Sector (HGX) index hit my November 2014 target of $250 to score a 21% gain in nine months. Toll Brothers (NYSE: TOL) reached my $42 target from July 13 to capture an 8% rise in about six weeks.
Now that these targets have been met, I am standing aside in housing sector-related assets for now, at least until the broader market becomes a little more stable.
Scared Stock Market Testing Support
Speaking of market stability, last week's stock market collapse propelled market volatility according to the Volatility S&P 500 index, better known as the VIX or the fear gauge, back to its recent high above 20. The index saw another huge jump on Monday, finishing 45% higher at 40.74.
The chart below shows that this is an extreme level of investor fear that has closely coincided with a number of near-to-intermediate-term bottoms in the S&P 500 during the past year.
By itself, this is not a reason to try to catch a falling knife by jumping right back into the market -- at least not until we see some signs of stability in the major indices.
The next chart shows the S&P 500 finished last week just below the bottom of the support band at 1,981 to 1,973, which are the lows from February and December. This would have been a logical place to expect some new buying to come in and prop up the market -- that is if we were indeed close to a near-term bottom as the previous chart suggested.
However, Monday's breakdown below 1,973 cleared the way for a deeper decline to the next support level at 1,940, the 61.8% Fibonacci retracement of the larger October-to-May advance. Since 1,940 was also broken on Monday, we could see an even deeper decline all the way back to the October lows at 1,821.
The takeaway here is that it may be time to start looking for a bottom, but way too early to assume one is in place.
Asset Flows for Gold are Bullish
In last week's issue, I said it was time to start paying attention to gold again as an alternative investment due to the recent increase of assets invested in SPDR Gold Shares (NYSE: GLD). GLD subsequently rose 4% last week.
The next chart shows these assets are now situated above their 21-day moving average, indicating a new trend of monthly expansion that is characteristic of sustainable price advances.
GLD also rose above its 50-day moving average last week for the first time since June, which suggests that a new minor bullish trend change is emerging. As long as these assets continue to expand, I will remain cautiously bullish on this ETF and other gold-related investments. However, it would take a sustained rise above GLD's 200-day moving average at $113.92 to suggest a sustainable bottom is in place at the recent lows.
Putting It All Together
The U.S. stock market correction we have been warned of all summer emerged with a vengeance at the end of last week, driving the benchmark S&P 500 down to important underlying support amid a big spike in volatility.
This sets the stage for a near-term market bottom to potentially emerge over the next week or two. But it is too early -- and too risky -- to assume one is in place until the market starts to stabilize from underlying support levels.
In the meantime, I continue to favor long-dated Treasuries, the utilities sector and gold as defensive investment alternatives.
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