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Tuesday, July 23, 2013

How Deep Will the Market’s Pullback Go?

Взрывозащищенные светодиодные заградительные о...
 (Photo credit: ГорэлтЕх)
By InvestorPlace

The unsustainable steepness of the slope in U.S. equities should lead to a mean-reversion move

New York, Jul.22, trading stocks .- While for the most part yesterday’s trading in U.S. equities could be labeled as a boring summer Monday trade, a few more eyebrow -raising observations can still be made.

As the S&P 500 did its best to hug the flat line, I first noticed how extended the financials are past the 200-day simple moving average. Specifically, the KBW Bank Index is now trading a solid 20% above this moving average. While not a record, this is still historically an area where the index began to look tired and soon thereafter slipped into a mean-reversion move lower.
As a side note, the financials again led the tape higher yesterday, with the Financial SPDR (XLF) rallying 0.68%.
Speaking of mean-reversion moves, my previous market outlook led to quite a few reader questions about my expected timing and depth for any pullback in stocks.
As such, allow me to first make clear that while my portfolio is currently tilted to the short side, I am trading around my short positions with quick long and short-side trades for cash flow.
Second, I consider U.S. stocks to have become a very crowded trade. But when it comes to expecting near-term weakness in stocks, I first and foremost am looking for a mean-reversion move lower as the steepness of the slope in U.S. equities simply isn’t sustainable at this rate.
Once some mean-reversion has set in, anywhere from 3%-5% lower, I would expect a second leg lower in equities, also around 5%, to finally lead to a better bottom-making process around the October-to-November time frame.
Given the strong push off the November 2012 lows in stocks, I imagine we could see a final overshooting in the S&P 500 toward the 1,700-1,720 area, which would thus target a first pullback just around the 1,600 area with a second push toward 1,500-1,530.
Homebuilding stocks, as measured by the PHLX Housing Sector (HGX) index, have been notable underperformers off the June lows. The higher interest rate environment is supposed to weigh on these names (or so the theory goes), which eventually and logically also will lean on other sectors at least until the first shock is absorbed.
Through a purely technical lens, HGX is tracing out a bearish topping pattern with a clear neckline around the 175 mark. If and when reached, this may also offer a good first reference level to measure downside momentum in the broader stock market.
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