Weekly Market Outlook: How Much More Downside Lies Ahead?

Includes: DIA, QQQ, SPY, VXX, VXZ
by: Price Headley, CFA

Things were going along just fine for the bulls…. until Friday. Not only did that day's 1.8% drop pull the market into the red for the week [the second in a row and the second in the last nine], but the tumble also dragged the market under some key support lines that will make it much more difficult for the bulls to keep rolling now.

The irony is simply that the size of Friday's implosion may well be enough to induce a quick snap-back rally. The question is, how much rally could we see?

As always, we'll dissect the action below, right after we run down last week's and the coming week's economic data.

Economic Calendar

Once again we got mixed signal on the real estate front. New homes surged to an annual rate of 329K for December, while total pending home sales grew by 2.0% in November. Both topped expectations. On the downside though, the Case-Shiller Index said house prices fell 1.6% in November; the FHFA Housing Price Index said prices were flat in December.

Jobs-wise, not only was the initial claims figure of 454K and the ongoing claims figure of 3.991 million higher than their prior readings, both were higher than forecasts.

On the confidence front, it was strength all around. The Conference Board's consumer confidence level shot higher from 53.3 to 60.6 in Januarys, while the final Michigan Sentiment Index number for January came in higher at 74.2.

The rest of last week's story is detailed on the economic calendar.

Economic Calendar

The coming week's got even more in store.

Things kicked off on Monday with updates on December's personal income and personal spending; the pros are looking for increases slightly better than November's modest improvements. We'll find out how much of that spending was on automobiles with Tuesday's auto and truck sales numbers.

The fireworks don't really begin until Wednesday though, kicking off with the Challenger Jobs Cuts figure and the ADP Employment Change number. The former fell 29% in December (that's a positive decline), while the latter is expected to improve by 150K after the 297K increase in January. We'll hear the usual ongoing and continuing claims numbers on Thursday (look for slight declines with each), and on Friday we'll get the biggie…. the unemployment rate, with a side of nonfarm payrolls growth. The unemployment rate is expected to return to 9.6%, despite the anticipated addition of 150K new jobs in January.

S&P 500

We knew we were due. We just didn't know when we were going to pay the piper. As it turns out, the answer to that question could be 'now'.

As was mentioned above, the S&P 500 took a 1.8% hit on Friday to close out the week down by 7 points (0.5%). It was only the second losing week in the last nine, but being the second loser in a row raises some questions.

Somewhat related, for the first time in a long time, the SPX closed under the moderately-important 20-day moving average line (blue). It was the first time we've seen this since late November. Though that slide under the short-term average didn't ignite a major correction at the time, the market hadn't rallied a nearly-uninterrupted 20% at that time either. Since late November though, the last 10% of the rally really carried stocks to a dangerously-overbought condition, which we saw the outcome of on Friday.

Volume was pretty strong with the move too, and the VIX sure made a decisive upward move.

All those signs point to a new downtrend, but here's the rub – violent selloffs invite strong buybacks…. at least for a while. We may well get a bounce early this week. Before plowing back in though, just bear in mind a great deal of technical damage has already been done. In fact, too much damage to unwind may have already been inflicted.

Point being, a rally from here isn't necessarily the same bullish sign it was a few weeks ago. Take a look, but keep reading.

SPX & VIX Daily Chart

The M.O. from here is simply to wait for the dust to settle now that the damage has been done. We're apt to get a bounce, but there's no assurance it will have any longevity. To fully appreciate just how much the undertow has changed (for the worst) here though, an examination of a weekly chart of the S&P 500 puts things in a different perspective.

In simplest terms, the weekly chart shows with much more clarity that (1) the VIX is working on a new uptrend, and (2) the S&P 500 gave us a really nasty reversal bar last week, with a low open and lower close despite a tall bar and hitting new multi-year highs. It's also with the weekly chart that we can see just how dangerously overbought the market was as of last week.

SPX & VIX Weekly Chart

While it's the daily chart that still suggests a downside target around 1190 is the right floor to look for first (about a 7% drop from where we are now, which still isn't a healthy correction), it's the weekly chart that sends a clear message about just how overextended and at-risk the market is at this point. It just may take a few days to really see this downside effort materialize.

Sector Performance

Normally this is where we'd insert a visual and numerical look at how each sector performed against one another for the prior week. After Friday though, the meltdown pretty much makes such an analysis pointless. So, since we have time and space – and since were in the middle of earnings season – we thought we'd switch gears and look at a sector-level earnings report card.

So, here you go…. beats, meets, and misses so far, with a little over 40% of the S&P 500's companies having reported last quarter's numbers.

Earnings Report Card

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.