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The Evidence for and Against an Imminent Correction in Stocks

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I am scratching my head this morning. I’m looking at a chart that makes no sense. If it says what I think it says, it is not good news at all for the stock market, and signals a correction before too long.

The chart is a short-term, 1-minute candle 1-day chart for Micron Technologies (MU), and it looks like this:

MU

It shows MU trading lower in the wake of its earnings release after yesterday’s closing bell. Nothing noteworthy there, until you look at the substance of that earnings report. Micron beat expectations for Earnings per Share (EPS), recording $1.88 vs. an anticipated $1.62, on higher than forecast revenue of $7.24 billion. It also issued guidance for next quarter in excess of Wall Street’s median forecast, giving them the trifecta of beats on important metrics. However, the stock dropped.

I cannot see a reason for that beyond market positioning and dynamics. The only possible thing would be if the consensus view of traders was that the announced sale of a Utah chip plant to Texas Instruments (TXN) was a bad deal for MU. I guess reducing capacity when continued strong demand is anticipated is not great, but selling assets at the time of peak pricing is never a bad idea. Doing that and expanding through acquisition when the cyclical chip market dips has been MU’s gameplan for a while, and they have been remarkably successful doing it.

If that were the reason, though, you would expect to see a simultaneous pop in TXN. I mean, if MU didn’t get a good deal, then TXN must have, right? And yet, TXN is barely moving this morning. The fact is that the long-term reduction of capacity that the sale represents would be more than offset by the $1.5 billion price tag in an environment where traders were looking for positive signs, but they aren’t. Those that are interested in MU are already long and looking for a reason to sell, no matter what earnings may show or even what the near future holds.

In a market that is hovering around record highs, that is potentially a big problem. It suggests that all the good news is priced in, and that means prices will stall at best, and more likely correct back soon.

There were several examples of this during an earnings season a couple of months ago, but here we are with the S&P 500, four or five percent higher than when the flood of earnings abated. Clearly there is a bullish influence or influences providing enough support to more than offset those fears when they come, but what are they?

Well, the most obvious thing, and the thing that I have been banging on about for a year or so now, is that both the Fed and Congress are pumping stimulus into a recovering market. That has an inevitable bullish impact no matter what valuations look like. Then there is another factor that seems to be propping things up, this time technical rather than fundamental. 

MU 2

The above is a chart for the S&P since early March with the blue line representing the 50-day simple moving average (SMA). As you can see, long-term trend line has acted as a support five different times in that short period. It is not point-perfect as we have traded below the level on four of those five occasions, but each time, the break has been immediately followed by a bounce. A drop of around 2.5% would take the S&P back to the 50 SMA, but to indicate a trend reversal, we would then need to stay below the line for at least a couple of days.

Weighing the evidence on both sides, it seems that we are in the same place we have been since November. There is nervousness among traders and investors creating short-term wobbles, even while fiscal and monetary stimulus keep the bull market going. If you were to say that can’t go on forever, I would find it hard to disagree. Even Congress and the Fed have limits to their largesse at some point. However, until a trend reversal is confirmed by a sustained break of the 50 SMA, you must see these wobbles, both in the overall market and individual stocks, as buying opportunities.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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