Friday’s dramatic reversal in the Russell 2000 and the tech sector confirmed the concerns I had been pointing out in Friday’s pre-market report giving us conviction in shorting the open hard: The push to new highs on the $SPX and $DJIA were simply not well founded. What are the technical implications of this reversal? While nobody knows where the market will go next at any given time it is useful to be aware of potential scenarios. When looking at a weekly Russell 2000 chart one scenario that sticks out is that of a potential large heads & shoulders build that is reminiscent of a similar build in 2011 when the Fed tried to stop QE for a while (which didn’t work out all that well of course):
What this chart points toward is a broken trend line of the trend going back to November 2012. This trend line was attempted to be recaptured but this attempt has failed in spectacular fashion with a renewed close below the daily 50MA. As the $RUT has tested its weekly 21MA several times now (Friday’s bell saved it from a break for the 2nd week in a row) this MA is now extremely vulnerable to a break.
Such a break, should it occur, invites a visit to the weekly 50MA which coincides with the February lows representing an area of confluence and hence strong support. A likely bounce from here then of course now invites the notion of a potential heads and shoulders build into the May/June time frame. A break of the neckline then would bring us to a target in the 951 area. Is this far fetched?
Not really, as it also roughly coincides with a 61.8% Fib retrace of the November 2012 starting point of this rally which sits at the 933 level. So a target range of between 933-951 would not be unreasonable:
But markets have been so strong, what could possibly cause such a deep correction? Quite simple actually: Tapering. My view has been that all this excess liquidity by the Fed, low rates, buybacks, margin debt, etc. has created an environment where capital sought high beta returns, and this is exactly where it ended up: High beta stocks. So who’s been struggling ever more since taper has started to really taper down? High beta. Tech and $RUT. It is no coincidence of course that this entire rally went in overdrive in November 2012 as it coincided with Ben’s QE infinity program.
What reference point do we have for what happens when the Fed cuts QE? Check the $RUT in 2011. Weekly heads and shoulders kissing its weekly 21MA and then the big break, ultimately only saved by renewed QE. Yes it really could be just that simple:
In summary: We may be in for one heck of a summer with tons of volatility and plenty opportunities from the long and short side. Best of luck!
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