Italian Election Scares Bulls

|
 |  Includes: DXJ, FXY, GLD, IEV, TLT, UUP
by: David Fry

Monday started off with bulls ramping stocks higher out of the gate. Then the Italian election results came out, and it doesn't appear likely that Berlusconi, Grillo, or Bersani will be able to form a coalition government. Worse was the result that there was no outcome, meaning the country had become ungovernable. (Wasn't that always the case?) But the stakes are high within the eurozone given coordinated efforts to deal with austerity and previous commitments. One sad aspect of the voting was the report that this was the lowest voter turnout since WWII. What does this reflect? Simply, voters feel helpless with the choices. (Let's not forget, this may apply to us as well.) Anyway, this event caused markets to abruptly reverse course. It created a bearish outside day technically when markets opened on their highs, then closed near the lows.

A chain reaction ensued, as investors suddenly remembered the UK credit downgrade and over-extended currency markets like the yen (NYSEARCA:FXY), which sold-off hard. European stocks (NYSEARCA:IEV) began the day sharply higher (as much as 2%), then sold-off to close unchanged.

Before all the bearish chaos, investors seemed to not notice the poor PMI data from China showing growth cooling once again (50.4 vs. 52.3) -- the worst in four months. Without China growth, you shouldn't expect too much global growth overall. It's just the way things are now.

All this chaos benefited the dollar (NYSEARCA:UUP), gold (NYSEARCA:GLD) and bonds (NYSEARCA:TLT). Selling in U.S. stocks was widespread, and took on a "crash-like, get-me-out" feeling. Some may be inclined to suggest the sequester was another reason for selling, but that seems a stretch, since most have stated it's going to happen. Even the POMO Monday didn't stop the bleeding.

Thankfully, our proprietary trading system kicked in with sell signals this weekend, and thus, raised our flagship portfolio to 40% cash.

Perhaps the chart of the day belongs to Wisdom Tree Japan Hedged ETF (NYSEARCA:DXJ), which was one of the biggest performers of the year until today.

Click to enlarge

Tuesday and Wednesday, the Bernank will have opportunities to repair stock market damage with uplifting hints and rhetoric, which is designed with that in mind. No doubt, the Fed has focus groups developing talking points for these two events.

Volume once again exploded to the upside, more than tripling Friday's rebound. Breadth per the WSJ was quite negative.

Click to enlarge

Continue to U.S. Sector, Stocks & Bond ETFs

Continue to Currency & Commodity Market ETFs

Continue to Overseas Sectors & ETFs

The NYMO is a market breadth indicator that is based on the difference between the number of advancing and declining issues on the NYSE. When readings are +60/-60, markets are extended short term.

The McClellan Summation Index is a long-term version of the McClellan Oscillator. It is a market breadth indicator, and interpretation is similar to that of the McClellan Oscillator, except that it is more suited to major trends. I believe readings of +1000/-1000 reveal markets as much extended.

The VIX is a widely used measure of market risk, and is often referred to as the "investor fear gauge." Our own interpretation is highlighted in the chart above. The VIX measures the level of put option activity over a 30-day period. Greater buying of put options (protection) causes the index to rise.

Concluding Remarks

The collapse Monday caught bulls by surprise. The destruction within many markets from currencies, equities and commodities was impressive. It just took one shot from Italy to put bulls to flight once they connected all the dots from around the globe.

There is plenty of impressive economic data this week. Bernanke steps to the plate Tuesday to calm markets, and perhaps reinforce this on Wednesday.

Markets have felt toppy for some time. It never ceases to amaze me how these light volume melt-ups, which take many weeks to achieve gains, see the rug pulled out from them on heavy volume in just one day or two.

Disclaimer: The ETF Digest maintains an active ETF trading portfolio and a wide selection of ETFs away from portfolios in an independent listing. Current "trading" positions in active portfolios, if any, are embedded within charts: Lazy & Hedged Lazy Portfolios maintain the follow positions: VT, MGV, BND, BSV, VGT, VWO, VNO, IAU, DJCI, DJP, VMBS, VIG, ILF, EWA, IEV, EWC, EWJ, EWG, & EWU.

The charts and comments are only the author's view of market activity and aren't recommendations to buy or sell any security. Market sectors and related ETFs are selected based on his opinion as to their importance in providing the viewer a comprehensive summary of market conditions for the featured period. Chart annotations aren't predictive of any future market action rather, they only demonstrate the author's opinion as to a range of possibilities going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.