Anything goes! Yesterday’s session was not one for those prone to motion sickness as stocks sank early on only to rip (trade up) later in the day and close slightly down. The Dow Jones Industrial Average was down as much as 549 points after the open but ultimately rallied late in the session with a close only down 126 points. It’s not often that I use the word “only” for a 126 point selloff in the index, but yesterday was one of them. Markets started off weak in overseas trading as nervous Asian investors passed the baton to European investors who were contemplating problems with Brexit and potential Italian contagion. As I reported yesterday morning, all eyes would be on the pre-market earnings releases however I could not have predicted the market’s severe response to them. By the time the market opened only 3 of reporting companies had missed their estimates but two stood out in the news cycle. 3M, the industrial conglomerate missed earnings and had a bit of a rough earnings call in which they singled out the strong US dollar for their woes. The negativity was not limited to currencies however as they cited rising costs, future earnings slowdowns, and a miss as well, a miss prompting investors to sell off the stock. Another industrial mainstay, Caterpillar announced that earnings beat estimates but softened future guidance. The company, which is considered an industrial bellwether, announced that tariffs and logistics were impacting its profitability. The company spoke of plans to raise prices in order to offset rising raw material costs attributed to the trade war. Caterpillar traded off as much as 10% in the session and ultimately closed down 7.6%. Those are just two examples of the types of earnings calls that cause investors to worry about stocks. Sure, things are going well for the economy now, but I can’t stress enough that the markets are trying to price in what will be happening in future quarters and that future story is starting to look a little…less huge.
The S&P500 bounced off of its 2688 Fibonacci line and ultimately posted a close above its 2736 Fibonacci line but still below its 200 day moving average (that was a mouth full but more on that below). The two Fib lines will serve as the index’s supports (see chart 4 in my attached daily chartbook). The Dow Jones industrial Average, which contains both of the aforementioned companies, bounced off of its 24875 Fibonacci line for a close just on its 200 day moving average, which will serve as its main support level, if it can hold in today’s session (see chart 6 in my attached daily chartbook). The Russel continues to follow its recently negative trend having bounced off of its 1508 Fib line but still closed below its low of 2 weeks ago, which is a negative signal (see chart 7 in my attached daily chartbook). The NASDAQ 100 managed to stay above its 7080 Fibonacci line and 200 day moving average as investors grabbed for the familiar growth stocks that got them out of trouble in the selloffs of the past (see chart 8 in my attached daily chartbook). Bonds traded up in response to the selloff in stocks yesterday offering some stability to investors who were diversified (see last week’s geek-out Wednesday note). Ten year yields will start today’s session at 3.13%. Crude oil had a rough session yesterday in response to Saudi Arabia’s plans to ramp up production to cover for Venezuela’s and Iran’s deficits. The Administration has been asking them to do this for some time and it’s interesting that they finally relented following the tensions that have arisen in the past week. In any case, West Texas Intermediate crude closed below its 200 moving average putting it risk off. Moving averages are an important tool to determine a trend and because today is geek-out Wednesday I will do a deeper, but quick, dive into moving averages.
Moving averages are perhaps the most followed technical indicator and they are used to smooth out daily price fluctuations in order to provide the viewer a cleaner, less noisy, view of a security’s trend. There are many different types of moving averages, but the most common one is the Simple Moving Average (SMA). The SMA is the sliding arithmetic mean of a determined number of past closing prices and it is calculated as follows:
(Close(t) + Close (t-1) + Close (t -2) … Close (t – d)) / d
where: t is today and d is the number of days being studied
This is calculated each day so that the moving average appears as a smoothed line, which is most impactful when plotted along with the closes of the underlying security. As the word “moving” in its name implies, the calculation is made daily, always accounting for the specified number of past closes… it moves. So if we want to get an idea of the short term behavior of a security, we might observe a 10 day moving average (which is two weeks worth of trading days). Likewise if we want to observe longer term trends, we might look at 100 or even 200 day moving averages. As the calculation only takes into account the number of days in the study, it represents a sliding window into a stocks behavior which drops the oldest closing price out of the calculation as it moves forward, which gives the viewer a good picture of a security’s behavior. Because the SMA is compiled from past closes it is said to be a “lagging” indicator only showing where a stock has been. The longer the period under observation, the bigger the lag. For example, if we are looking at the 200 day moving average, we would be starting with a closing price from 200 trading days ago, which would have as much impact as the close yesterday. Because of this, as you might suspect, there are many different types of moving averages, all of which attempt to smooth out daily price vagrancies and give the viewer a cleaner picture of a security’s behavior. One example of another popular moving average is the exponential moving average (EMA), which attempts to weight more recent closes more heavily than older ones. So in my earlier example of the 200 day SMA, that close from 200 days ago is given less weight than yesterday’s close. This makes the indicator less laggy and provides, perhaps a slightly more accurate picture. I will spare you the calculation for the EMA, but it is important to note that there are many different ways to calculate a moving average all of which attempt to provide a more accurate, less lagging view of a security. There are some pretty complicated ones out there, but the most common are the SMA and EMA. As with most technical indicators it is important to understand not only the indicators themselves, but also who might be using the indicators to influence trading. Traders like to know what other traders are thinking, so if we know that most of them look at one type of moving average, we would be smart to be looking at the same indicator.
That said, almost all traders look at the 50, 100, and 200 day moving averages. If they are all pointing in the same direction a security is said to be trending. If a faster indicator (50 day) crosses over a slower MA (100 day) we know that a security’s shorter term behavior is different from its longer term behavior, indicating a possible shift in sentiment. So for example if a positively trending stock’s 50 day moving average goes below its 100 day moving average a trader might view it as a sign that the stock is about to turn around. The trader might sell her position in response to the cross over. Another way traders like to use the indicator is to determine if a stock is trading along with its trend so if daily closes start to trade significantly above or below a moving average, a trader may believe that a trend is strengthening or reversing. For example, if a positively trending stock is trading well above its 200 SMA, this will signal that the trend is strong and will continue to move in a positive direction (this is also mathematical fact as higher closes will increase the average… see above). Conversely, if the stock begins to close below its 200 moving average, it indicates that a stock is perhaps changing direction and will start causing the trend to weaken and possibly turn negative. The 200 day simple moving average is perhaps the most watched indicator of long term trend by all types of investors. Although they would never admit to it, most hotshot quant hedge fund managers use it to generate trade signals. Yes the very simple, “simple” 200 day moving average. This is why I include it in all of my charts in the daily chartbook. It is the solid blue line on the top panel. Of course many analysts are constantly on the search for a new, top secret indicator that will tell them exactly where the market will trade today, if not in the next 5 seconds. But if we know anything from history, the stock market represents the sentiment of the crowd and if the crowd is looking at the 200 day SMA as an indicator of health, then so should you.
Today we have a number of economic releases as well as another raft of pre-market earnings reports. This morning we will get House Price Index, which is expected to show an increase of +0.3% for August. Manufacturing PMI is expected to come in at 55.3 after last month’s 55.6. Also this morning, we get another housing number (housing has been somewhat disappointing lately) in New Home Sales, which is expected to have fallen by -0.6% month over month. This afternoon, we get the Fed Beige Book which will provide us with a report of economic health across all of the Fed regions. All of these can be market movers in this environment. Of course center stage will be taken by a large number of pre-market earnings releases which will feature a number of industrials and defense companies, amongst others. After the close we get into some tech and growth heavy weights which, if well received, may be just the thing to cure this ailing market. As with yesterday, it is difficult to tell how the market will react to the actual numbers as the narrative around the numbers is becoming increasingly more important. Also similar to yesterday, today will be another day of increased volatility which will likely include several coffee runs before lunch arrives.