What Do Stock Traders Fear The Most?

Benzinga

If ever there was a self-fulfilling bearish prophecy, this was it. Everybody, everywhere has been watching the same lines in the sand, the same data, the same earnings guidance, and the same speeches by Fed officials. Everybody, everywhere knew that internal momentum had been waning, that complacency was running high, and that if the S&P 500 broke below important support, it would lead to an almost instantaneous "whoosh" lower. And sure enough, from the very moment the futures broke below the equivalent of the 1680 on the S&P 500 early Thursday morning, this is a good time to be cautious.

After having been frustrated mightily for the vast majority of the past nine months, the bears must be feeling pretty good right about now. And while the S&P is only off 2.8 percent from its August 2nd high, everybody, everywhere assumes that stocks are heading lower from here.

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The excuses du jour for Thursday's rout in the stock market were many and varied. For starters, apparently Cisco Systems (NASDAQ:CSCO), which is known for manufacturing earnings that impress by a penny or so, didn't have good things to say about the future after the close on Wednesday. Next, the yen-carry trade began heading the wrong direction overnight on concerns that corporate taxes in Japan won't be reformed after all. Then there was the Wal-Mart (NYSE:WMT) report, which also raised some concern about the coming quarters. Next, the yield on the 10-year U.S. government bond spiked to a fresh high for the cycle.

The yield spike, the yen rally, and the guidance issues from two very big names were clearly the triggers for the selling on Thursday. And to be sure, there were algos chasing algos once the S&P's line in the sand at 1680 was breached. However, it is important to recognize that there are other big-picture worries out there as well. And the bottom line is the combination of the big-picture stuff and the near-term catalysts simply overwhelmed anybody interested in doing some bottom-fishing on Thursday.

Any time there is an important break in the market, it is important to understand why the move occurred. Yes, algos can certainly both create and reinforce a move. However, markets don't just dive 225 points just for the heck of it. No, there is usually a reason to be found for the move.

How long can Thursday's dive go? And for that question, the big picture needs to be examined.

The question for this morning is actually the title of this morning's missive: What does the market fear most? There are the usual suspects: China growth, the budget battle, Europe's banking system, the calendar, interest rates, valuations, the economy, the Middle East and the Fed. But in all honesty, with the exception of the renewed rate surge, nothing on this list was new. And as anyone who has been at this game a while knows, markets can deal with just about anything - as long as there are no big surprises.

Uncertainty is the real issue of the day. Uncertainty about what to expect going forward is the reason folks take profits, reduce risk, or decide to "go the other way" for a while. Uncertainty is what causes traders to say, "I've seen enough, the market can do its price discovery without me." And uncertainty winds up being the primary cause of the big declines.

The key question here is if there is enough uncertainty at the present time to turn a garden-variety pullback into a meaningful correction. Is fear of a "policy mistake" by the Fed enough to cause a decline of more than 5 percent? Is the uncertainty over when "the taper" might start significant enough? Will the unknown of how "the taper" might actually impact the markets do the trick? Can the concern about the lack of revenue growth morph into a focal point that keeps traders' attention for more than a day or two? And what about the bite that rising rates might have on the economy? Are any of these worries big enough to warrant another mid-year dance to the downside?

It is actually much more important to know what the questions are than the answers. This may be beating a dead horse here, the real question is what is the market worried about the most?

Frankly, this is one of those times when the tape may indeed tell all. Although most of Wall Street traders are at the beach with their kids, what the market does over the next week or two will likely answer some or all of the questions posed this fine Friday morning.

Current Market Drivers

Success comes from understanding the driving forces behind the market action on a daily basis. The thinking is that if one can both identify and understand why stocks are doing what they are doing on a short-term basis; it is unlikely one will be surprised/blind-sided by a big move. Listed below are some of the driving forces of the current market (listed in order of importance).

1. The State of Fed/Global Central Bank Policies 2. The Outlook for the U.S./Global Economy 3. The Level of Interest Rates

The State of the Trend

It is important to analyze the market using multiple time-frames. Short-term is 3 days to 3 weeks, intermediate-term is 3 weeks to 3 months, and long-term is 3 months or more. Below are the current ratings of the three primary trends:

Short-Term Trend: Negative (Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Moderately Positive (Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Positive (Chart below is S&P 500 daily over past 12 months)

Key Technical Areas:

Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the important levels to watch today:

  • Near-Term Support Zone(s) for S&P 500: 1655
  • Near-Term Resistance Zone(s): 1680

The State of the Tape

Momentum indicators are designed to determine the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of indicators relating to the market's "mo"...

  • Trend and Breadth Confirmation Indicator: Neutral
  • Price Thrust Indicator: Positive
  • Volume Thrust Indicator: Neutral
  • Breadth Thrust Indicator: Neutral
  • Bull/Bear Volume Relationship: Positive
  • Technical Health of 100 Industry Groups: Moderately Positive

The Early Warning Indicators

Markets travel in cycles. Thus traders must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.

  • Overbought/Oversold Condition: The S&P 500 is oversold from a short-term perspective and is low neutral from an intermediate-term point of view.
  • Market Sentiment: Theprimary sentiment model is negative .

The State of the Market Environment

One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward because different market environments require different investing strategies. To help identify the current environment, look to the longer-term State of the Markets Model. This model is designed to determine when risk factors are high, low or uncertain. In short, this longer-term oriented, weekly model reveals whether the odds favor the bulls, bears or neither team.

Weekly State of the Market Model Reading: Moderately Positive - The weekly model is positive. This suggests to continue to favor the bulls.

If you are looking for a disciplined, rules-based system to help guide your market exposure, check out The Daily Decision System.

Turning To This Morning...

Anyone looking for a global market crash following Thursday's thrashing on Wall Street will likely be disappointed this morning. While there was massive volatility in China (the Shanghai stock index moved from -1% to +5% in minutes before lunch), most markets have held up fairly well in the face of the Dow's 225 point dive. Europe is mixed in the early going and U.S. futures point to a rebound attempt at the open on Wall Street.

Pre-Game Indicators

Here are the Pre-Market indicators to review each morning before the opening bell...

Major Foreign Markets: - Japan: -0.75% - Hong Kong: -0.09% - Shanghai: -0.67% - London: -0.08% - Germany: -0.24% - France: +0.09% - Italy: +0.38% - Spain: +0.36%

Crude Oil Futures: +$0.19 to $107.52

Gold: +$3.30 to $1364.20

Dollar: lower against the yen, higher vs. euro and pound.

10-Year Bond Yield: Currently trading at 2.788%

Stock Futures Ahead of Open in U.S. (relative to fair value): - S&P 500: +3.27 - Dow Jones Industrial Average: +13 - NASDAQ Composite: +4.17

Thought For The Day...

Unthinking respect for authority is the greatest enemy of truth. -Albert Einstein

Wishing you green screens and all the best for a great day,

David D. Moenning Founder and Chief Investment Strategist StateoftheMarkets.com

Positions in stocks mentioned: none

Forget the fast money and the latest, greatest option trade. What investors need is a strategy to keep them in the stock market during bull markets and on the sidelines (or short) during bear markets. The Daily Decision System Can Help

For up to the minute updates on the market's driving forces, Follow Me on Twitter: @StateDave (Twitter is the new Ticker Tape)

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