an tSionna {Yesterday's Decline}

Most of us are  aware that stocks suffered a rather large decline yesterday. Much of the snap commentary has focused on the probable computer glitch that knocked an additional 500 points off of the Dow Jones Industrials for about 10 minutes. Unless you sit glued to a computer screen all day you probably didn't even know there had been a problem until you turned on the news or went on the internet.

This is not the first time that stocks have suffered a computer meltdown and it will probably not be the last. Unfortunately that is the price we pay for the way modern markets operate, which by the way also includes increased liquidity and lowered commissions as benefits.

While not trying to minimize what happened, I think it will ultimately be found to be a combination of human error and computer trading gone amok. Indeed the exchanges have already stated that they will likely cancel certain trades executed during that time. Ultimately whatever caused that part of the decline will be discovered and addressed.

However, markets were already down before that event and ended up losing nearly 3% by the close. I think its more important to focus on that portion of yesterday's decline and to also address what that means going forward.  

First as a review, I noted at the end of March that I had started to change my thinking to a more defensive posture given the advance we'd seen off the February lows and what my money flow analysis was beginning to suggest was a subtle change of trend. I also said on April 28th "that the market may be using the news out of Greece and Europe as an excuse to sell. The real culprit likely is that we've experienced a great rally and stocks are tired."

That defensive orientation included a review of all client accounts by investment strategy and risk. This has already meant raising some cash on a tactical basis based on account strategy, size and client risk parameters (see that same April 28th post and our game plan: An update post). In all cases it has included a strategic review of our exposure to the markets given the criteria previously mentioned. That review has also identified additional levels where we would become even more defensive in the event this correction morphs into something more serious. 

As I'm writing this, stocks have currently declined a bit more than 8% from their late April highs. This is similar to the other corrections we've seen since this rally began back in March 2009. I've shown for comparison in the chart above how this decline stacks up with our two most recent declines. {You can double click on the chart to make it larger and easier to see}. The previous two corrections in October and January of this year were nasty, brutish and short. So far this correction seems to fit with those previous events in both the intensity of its decline and the approximate number of days it's taken to get to this point.   Also a 2-3% one day decline while not common does occur more frequently than is commonly thought.  On average markets will experience a day like today 2-3 times a year.

This current decline has now taken us back to the same levels that stocks traded as recently as January-which was an area of consolidation where stocks have some support. One of our first clues as to future market direction will be how stocks react to this support level which resides around 1110-1115 on the S&P 500. {Again you can see that in the chart at the top of this page.}

Of course the real question is whether this is a correction similar to the half dozen or so we've seen since last spring or the start of something much worse.  I'll discuss  tomorrow what the evidence suggest about this current decline. 

*Long ETFS related to the S&P 500 in client accounts.

(Blue highlights represents links to older posts)