This Correction Could Turn Into A Crash

|
Includes: BXUB, BXUC, DDM, DIA, DOG, DXD, EPS, FXY, GLD, IVV, IWM, LLSC, LLSP, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWM, RYARX, RYRSX, SCAP, SDOW, SDS, SFLA, SH, SLV, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, TALL, TLT, TNA, TQQQ, TWM, TWOK, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTWO
by: Damir Tokic

Summary

We had more negative unexpected news last week.

Selling into negative news increases the chance of a more serious crash.

Negative news also causes more shorting, which increases the chance of short squeeze.

We are in the stock market (NYSEARCA:SPY) correction. Looking at S&P 500 futures on an intraday basis, we had about 3.4% correction from March 1st (intraday high) to March 27th (intraday low). Other than just the percentage correction, take the element of time - the uptrend has been interrupted for over a month now. So, definitively, we are at least in a corrective dip. Additionally, the "VIX correction indicator" F1-F2 Spread just inverted, as in all previous corrections, reaching -1% value on Friday, April 8th.

I have been calling (and many have been hoping) for a deeper correction to about 200-day moving average at around 2200 for the S&P 500. My reasons: the market has to acknowledge at least the delays with the implementation of many Trump fiscal stimulus promises as well as the potential shortcomings in actual policies. Further, the market has to acknowledge the negative aspects of likely protectionist policies. Simply, the excess Trump optimism has to deflate.

So, why are we not getting this deeper correction, which would be healthy for the markets? We were getting close to the selloff last week, but the market kept bouncing back. Here is why - the situation has dramatically changed last week - to more negative. Specifically,

  • We have learned from the Fed minutes that the Fed thinks that the markets are overvalued, AND, they actually might be worried about this.
  • The jobs report of Friday was not good - so the recession risk is definitely rising, and this was unexpected.
  • The Trump administration got involved in the Syrian conflict, which was also unexpected. So, the geopolitical risks are significantly rising now too.

Note, all of these are unexpected additional negative events, which actually should have triggered the "deeper correction" to the 2200 level. But the market remained resilient. Why?

Because, if you sell now in response to these unexpected negative news, the widely expected correction could actually turn into a much deeper stock market crash, as liquidity dries out, and the bids are removed as uncertainty increases. So, longs have to delay selling. In fact, longs would prefer to "mask" the negative news and sell into strength.

In my opinion, as long the 2.30% support holds on 10Y TBonds (NYSEARCA:TLT), the market will ignore these additional risks. But if this key support is broken, now we could have a situation where "everybody runs for the exit at the same time" - or the stock market crash.

Why? Now, the breach of the 2.30% level would not only indicate the end of Trump reflation trade (which would cause only a correction), but also possibly indicate the rising recessionary fears, especially if the yield curve flattens, which points towards a bear market.

With that said, a bounce in the 10Y TBond yields back towards the 2.60% level would likely to cause a massive short squeeze, given the recent unexpected negative news, which would also cause the selloff in gold (NYSEARCA:GLD), silver (NYSEARCA:SLV) and yen (NYSEARCA:FXY). So shorts, beware, longs would prefer to sell into this potential short squeeze. So, all eyes on the 2.30% level.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

About this article:

Expand
Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here