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Don't Panic Yet

The S&P 500's momentum persists, but we have to be ready for a reversal.
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Judging by the number of footballs flying through the air on my TV, I'd say summer is just about over. The next Federal Open-Market Committee meeting is scheduled for mid-September, and since a tapering of quantitative easing is almost assured in just over a month, is it time to bail out of the market?

As usual, I'll let the chart be my guide. The S&P 500 is facing an important test. Last week was the worst week in nearly two months for the overall market, and with this morning's gap lower, we opened at a major support level. The area near 1687 first came into play on May 22, when Fed Chairman Ben Bernanke slapped down an over-exuberant market that had reached an all-time intraday high. This morning, we successfully tested that level, trading beneath it briefly before recovering.

The purple line extending from the May 22 high (arrow), shown here on the SPDR S&P 500 (SPY) demonstrates how that level is now acting as support. The index might even be forming a small double top pattern right on that level. This would be indicative of a minor pullback, but it's not a cause for panic. Keep in mind that the market is still trading close to its all-time high.

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Thus far, the index's momentum is holding it up, and we remain long. However, the market has made virtually no progress during the past four weeks, so we have to be ready in the event of a reversal. We've done well by being long, and so have many others. This brings a thought to mind: Where there are major profits, there is a chance for major profit-taking. As long as we remain above the 50-day moving average (blue), and as long as we don't sell off sharply on high volume, I'll stay the course. We're still long a good number stocks, although we have trimmed some shares here and there.

Why isn't it time to panic? After we have heard so much input from so many Fed officials, the market is now prepared for tapering. Markets react strongly when they are surprised by an outcome, but there is little chance of a surprise in this case. Therefore, any selloff related to tapering has been priced in to some extent.

One indicator to watch here is the U.S. dollar, which, after sliding last week, has gained slightly today. Dollar strength is often a troublesome sign, as it could signal that traders are shunning risk for safety. On this front, there appears to be little of concern. After flexing its muscle earlier today, the dollar has relinquished most of its gains.

The same can be said about the reaction of the Japanese yen to last night's soft GDP figure. Like the dollar, the yen is a "risk-off" indicator, as it tends to strengthen when stocks fall. After initially gaining on weak economic news overnight, the yen reversed and softened. We're still long the Japanese yen against  the U.S. dollar, but with the understanding that if our currency trade works out too well, it could pose a problem for our equity holdings. 

At the time of publication, Ponsi was long JPY vs. USD,