Mediocre Bounce Suggests More Downside Ahead

After ugly action on Thursday, the market gapped down at the open on Friday, but dip buyers immediately appeared and drove the indices higher until about midday. In the afternoon, the action slowed, and the sellers returned in the final minutes of trading.

It was unimpressive action after the tough hits to AI, growth names and speculative favorites. The biggest concern was the poor breadth. Only about 42% of stocks posted gains, and new 12-month highs contracted to just 85 names, versus over 400 new 12-month lows.

In recent years, traders have grown accustomed to V-shaped recoveries after a sharp selloff, but that is not normal behavior. Typically, the market does not go straight back up after a severe hit. Investors who were caught with too much exposure will reduce their exposure into the bounce, which weakens it and causes the market to roll over again.

The more normal pattern is for a low to be tested at least once, and if it holds, then the conditions are better for a bottom to form. A one-day V-shaped bounce is not a good technical setup for a lasting low.

The good news is that we now have a very clear technical level at the low on Monday morning. For the S&P 500, that level is 6,647. If that level is breached next week, it will cause some very severe problems and trigger another round of selling.

Another interesting aspect of this action is that some stocks have already corrected quite deeply and are in technical bear markets. The indices don’t do a very good job of reflecting the pockets of disaster, just like they often fail to reflect the pockets of strong momentum.

I see quite a few stocks that are already beaten down so much they look like value plays. That doesn’t mean they won’t go lower, but when market conditions improve, the stock pickers will be focused on finding quality names that were unfairly punished by the broad selling.

We have some challenges to face, but the timing is interesting with the possibility of seasonal strength at some point in the next six weeks.

Have a good evening. I’ll see you on Monday.

At the time of publication, DePorre had no positions in any securities mentioned.