Last Thursday I mentioned in my comments that we were at a critical juncture and that the price action the rest of the week would determine direction for the next few weeks. Friday the market closed near its low of the day and it breached the 50-day MA. That was a warning sign and the S&P 500 is down 80 points overnight.

I mentioned the Evergrande collapse (Chinese real estate giant) as a problem and that they are likely to default on an interest payment due this week. China has been on my radar for months. If the world is coming out of the Covid correction and there is pent up demand, why is the market of the global growth engine (China) in bear market territory? In my opinion this has been a gigantic disconnect especially when you consider that China has had a 10 month head start on the rest of the world. China’s market was down 3% overnight.

Reasons to stay long:

1.Central bank money printing has pushed interest rates to historic lows and bond yields do not keep pace with inflation (negative real returns).
2.All of this money has to go somewhere and stocks are still the best alternative.
3.Corporate buybacks are reducing the supply of stock. Lower supply and higher demand means higher prices.
4.Economic numbers have been solid (although slightly below expectations).
5.The upward momentum is very strong and the dips are shallow and brief.

Reasons to be careful:

1.The forward P/E on the S&P 500 is at 21 and the last time it was this high was in 2000 before the “tech bubble”.
2.Earnings comps will be harder to beat because we were starting to rebound from Covid a year ago.
3.September is a seasonally weak month.
4.The Fed will start tapering in 2022. Europe will start sooner and S Korea raised rates a few weeks ago.
5.VIX is low and that suggests that Asset Managers are unhedged. Big drops happen when no one is expecting them.
6.Covid is hampering global growth.
7.There have been seven consecutive higher monthly closes on the S&P 500 and in the last 25 years there have not been eight.
8.We have seen selling pressure the last week. The market is opening on the high and closing on the low (red candles). That is a bearish pattern.
9.The debt ceiling needs to be raised by Sept 30th and Republicans are digging their heels in. This will come down to the wire and the market won’t like it.

Swing traders with a 3-4 week horizon should stay sidelined. You’ve heard this for months from me and I in hindsight I was too cautious. We missed some upside, but we are safely on the sidelines right now. We will watch our favorite stocks as they go “on sale”. The SPY has not touched the 100-day MA in a year and it is likely to do that today. Don’t buy now. We need to wait for concrete support to be established and big drops like this go through a bottoming process. That means there will be time for us to evaluate.

Day traders should wait for the dust to settle this morning. The market will be super volatile for the first hour. If you decide to trade, trim your size and use wide stops. The only pattern that would get me to trade early is 4 consecutive long green candles stacked one on top of the other in the first 30 minutes of trading with little to no overlap. That would signal a gap reversal and it is VERY unlikely. Option bid/ask spreads will be a mile wide and I suggest you keep your trading very light. Short stocks, but don’t trade options.

The worst day trading scenario is a drop early and steady continuation. I won’t join that “gap and go” move because the threat of a violent snap back rally is huge. Remember we are still in a bullish up trend and buyers are not going to roll over without a fight.

The best day trading scenario is an early bounce that fills in some of the gap and that hits resistance after 30-45 minutes of trading. That move will help me identify relative weakness and it will give me time to evaluate stocks and the market. “Jacked” option IVs will drop and the bid/ask will also tighten on this type of move. I will be looking for opportunities to short. I will be watching for tiny mixed candles on that bounce and a bearish 1OP cross. Then I will be looking to take short positions. I feel that the SPY 100-day MA will be in play this week.

Support is at SPY the 100-day MA and resistance is the 50-day MA.