Friday, January 28, 2011


It is always interesting how extended markets always find a good reason to finally correct. According to the media, stocks never correct because they have become expensive or extended. There is always a catalyst or news event that receives the blame.

Today we had a number of good excuses for some selling. Earnings reports from AMZN, MSFT and F were lackluster, the fourth quarter GDP numbers came in soft, and then there was the big one, the unrest in Egypt. The market focused on Egypt because it creates the most uncertainty and raises speculation that unrest could spread throughout the Middle East.

Whatever the reason for the selling might be, the aggressiveness of the selling today warrants our attention. Breadth was nearly 5 to 1 negative, volume was heavy, and we have a clear technical distribution day.

The technical picture of the Russell 2000 small-cap index is particularly worrisome. After the breakdown a week or so ago, we now have a failed bounce and a lower high. We are still holding the 50-day simple moving average, but that support doesn't inspire much confidence.

The Nasdaq has a similar setup, but it bounced bigger after the initial pullback and has already breached the recent lows. With any sort of downside follow-through, we will have a broken uptrend line and the start of a downtrend.

We definitely can't be overly confident about downside, given how often and how fast this market comes back every time it looks like it is on the verge of a major breakdown, but on the other hand, we can't be confident that this time it won't be different. It is better to be defensive and to err on the side of caution than to risk good gains in a market that is exhibiting some cracks.

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