Why Stocks are Crashing

The S&P 500 lost as much as 229 points or 10.92% in three days. The Nasdaq lost as much as 763 points or 16.77% over the same three days.

Wow. To be honest, I did not see that one coming, at least not as intense.

However, there were tell tale signs – a writing on the wall – that a big selloff is a real possibility. There was no reason for us to own stocks.

Here are three factors that caused (or certainly contributed) to this 3-day meltdown, and what they mean going forward:

‘Bad Breadth’

We have looked at the market’s internal deterioration (‘bad breadth’) many times in recent weeks (the last time was here).

The July 19 Profit Radar Report published this chart and warning (the S&P closed at 2,126 that day):

Although investors are buying, the surge in demand (appearance of buyers) has not been commensurate to the surge in price. The percentage of stocks above their 50-day SMA graph shows that investors are very selective right now. Only 41% of NYSE stocks are above their 50-day SMA, compared to 71% in April and 61% the last time the S&P was near 2,130 (late May). There’s a short-term bearish divergence, as the S&P 500 moved higher on Friday, but the percentage of stocks above their 50-day SMA lower.”

Mutual Fund Cash Levels

The August 2 Profit Radar Report looked at mutual fund cash levels and noted the following: “One of the bigger worries could be mutual fund cash levels, which just dropped to 3.2%, an all-time low. If a large number of investors decide to sell, fund managers will be forced to sell fund holdings, which has the potential to turn into a chain reaction.”

Elliott Wave Theory

Elliott Wave Theory. Some love it, others hate it. I’ve found that there are times where EWT is very helpful, if interpreted correctly.

The August 16 Profit Radar Report said this about the bearish potential of EWT:

A break below 2,052 may indicate a wave 3 lower.”

What is a wave 3? The third wave of an Elliott Wave pattern is always the most powerful one. It generally goes further than expected.

What’s Next?

Elliott Wave Theory may hold the most clues about what’s next for stocks. Based on the intensity of this selloff, it is likely to turn into a 5 wave decline with a more lasting low in October, similar to 2011. Here is how things looked and turned out in 2011.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

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The Most Bearish Week of Q1 is Almost Over – What about April?

This is a good news, bad news kind of scenario. The bad news: The last week of March is one of the worst weeks (seasonally speaking) of the first quarter. The good news: The worst week is almost over. Now what?

‘Triple Witching’ (when stock options, stock index options and stock index futures expire) is often a turning point for stocks.

This was the case again this year. The March 21 Profit Radar Report pointed out that: “The S&P 500 closed lower on Triple Witching day 15 out of 21 years (71%). The week after Triple Witching ended with a loss 14 out of 21 years (66%).”

This statistic is based on the performance of the S&P 500 tracking ETF (NYSEArca: SPY) since its inception in 1993.

Looking at seasonality, based on the S&P 500 since 1950, paints the same picture.

The chart below shows S&P 500 seasonality based on:

Seas32714

Every year since 1950
Every midterm presidential election year since 1950
Every midterm year since 1950 with a democratic president
All three seasonalities show pronounced weakness in late March.

What’s in store for April?

A full 2014 seasonality calendar is available to subscribers of the Profit Radar Report, but here’s a look at an index that sports a real unique telling pattern.

Russell 2000 Slices Below Support and Captures First Target

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

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Insider Selling of Stocks is at Highest Level for the Year

Insiders are fearful of an impending sell off. When this happened earlier this year the S&P 500 quickly declined 10%. Other sentiment measures are reaching extremes too, but there’s a silver lining.

All major U.S. stock indexes continue to trade near multi-year highs, but insiders are selling stocks of the companies they own or manage at a pace not seen at any other time in 2012.

Investors Intelligence reports eight sales for each purchase and considers the current rush for the exits “panic selling.” The question we should ask is, “what do insiders know that we don’t?”

Another sentiment extreme can be seen in the high yield bond market, more appropriately called junk bonds. Companies just issued the third-highest amount of junk bonds.

The prior records were set in October 2010 and May 2011. Those two dates are marked in the chart below. I’ll explain in a moment the significance of those two dates.

Mutual fund managers tracked by the National Association of Active Investment Managers report that managers have a median exposure of 95% to equities. This is close to a six-year high and sets an 18-month record.

The Dow Jones just went an entire quarter without losing more than 1%. Jason Goepfert with SentimenTrader took a look at what happens historically when the Dow goes an entire quarter without a 1% decline, while trading close to a 52-week high.

There were 16 such instances since 1900. Over the next six months, the Dow was positive every time with a median return of +6%.

Getting back to the two dates highlighted in the chart above, we are currently in a situation where sentiment is becoming extreme. But just as Advil covers up pain, QE3 tends to neutralize extreme optimism.

Back in October 2010 it took several months before sentiment extremes caught up with stock prices. In May 2011 however, it resulted in a nasty sell off.

From a seasonal perspective October is an interesting month. It has hosted a number of crashes but also a number of important lows.

Looking at stocks, we see that the S&P 500 (S&P 500 SPDR – SPY) has been trading in a well-defined parallel trend channel. The strategy – as long as the S&P remains within this channel – is to sell when it reaches the top of the channel and buy at the bottom.

Once the bottom (of the channel) falls out, it’s probably time to become more bearish.

The Profit Radar Report monitors literally dozens of sentiment gauges, seasonal patterns, and technical developments to identify high probability investment opportunities for the best investment strategy.