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Rally May Find Legs in Factory Data, Deal News but Volatility Persists

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August 26, 2015

U.S. stocks positioned for another rally attempt, with Wall Street spurred on by China’s scurry to plump up the globe’s second-largest economy and stop—or at least slow—the sharpest stock free fall there in nearly 20 years.

A strong reading out of the U.S. factory sector soothed nerves as well. Could it be? “Good” economic news is now welcome news and no longer seen as a trigger for aggressive Federal Reserve action. For now, it looks that way.

Upbeat early news does not permit complacency. Tuesday’s twist between gains and losses, culminating in a final-hour retreat, is a reminder that volatility—newly shaken from its 2015 nap—could be around for a while. There’s pain and possibility in Wall Street’s failed attempt to rally from the Dow Jones Industrial Average’s ($DJI) worst three-day point decline in history, not to mention the some $900 billion wiped out of the S&P 500 (SPX) this week.

Sideways trading, in SPX in particular, could take hold. Key chart points (figure 1) are in a narrow band, but some true tests within this band could set up our next leg. Watch for nearby resistance at 1925 and from there, at 1952. On the downside, holding 1900 could prove a major psychological coup.

SPX-rally-attempt

FIGURE 1: CHART POINTS.

The S&P 500 (SPX) logged its sixth straight down day Tuesday. From here, watch for resistance at 1925 and 1952. On the downside, 1900 stands as major psychological support. Data source: Standard & Poor’s. Chart source: TD Ameritrade’s thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Watch VIX

The broad market’s “fear gauge,” the CBOE Volatility Index (VIX), has roared back to life to say the least in recent days. Last week, the VIX posted its largest ever weekly jump at 118%. It hit seven-year highs this week, pushing briefly north of 50.

But within that context, an interesting development took hold late Tuesday. As the SPX fell late in the day, VIX did not snap back as might be expected (figure 2). Keep an eye on this measure. Important, too, is the muscle (or lack thereof) in the “safe haven” shift into bonds. People are plenty spooked, sure, but their market response may not reflect outright terror.

Watch-Volatility-Measure

FIGURE 2: VIX DECOUPLES?

The CBOE Volatility Index (VIX) tickled 50-plus earlier this week, its highest level in nearly seven years. The index had gained 45% or more in total on two consecutive days, the first time that’s happened in the history of the index. But late Tuesday, when the broader market resumed its slide, VIX remained lower. Data source: CBOE. Chart source: TD Ameritrade’s thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Here’s what’s driving today’s action:

China at it Again

The People's Bank of China moved to juice the economy again on Wednesday, saying it will inject 140 billion yuan ($21.80 billion) into the financial system through a short-term liquidity operation. Wednesday's move comes a day after the Chinese central bank cut its benchmark interest rate (the fifth cut since November) and lowered the reserve-requirement ratio for banks.

The latest actions may have slowed the stock market’s bleeding but did not stop it; the Shanghai Composite closed down 1.3% Wednesday. Chinese stocks have now extended what’s been the steepest five-day drop since 1996. The rest of Asian equities markets closed mixed and Europe has flip-flopped between gains and losses.

Durable Data

Orders for long-lasting U.S. goods rose 2% in July, led by demand for autos and military hardware. That was much stronger than the seasonally adjusted 0.6% decline forecast by Street economists. Durable goods orders minus transportation, however, rose a smaller 0.6%.

Here’s a valuable number: orders for core capital goods, which is one proxy for business investment, gained 2.2% last month, the most in 13 months.

Some Business as Usual?

Deal news hits the oil patch. Schlumberger (SLB) is acquiring oilfield equipment maker Cameron International (CAM) in a stock and cash transaction valued at $14.8 billion, or roughly $14.44 per share. The deal represents a 56% premium to Cameron's closing stock price Tuesday, sending its shares up some 40% initially. The news hits even as Wall Street frets over the durability of pending takeover deals—including Shell’s (RDS.A, RDS.B) $70 billion bid for over-the-counter traded BG Group and Halliburton’s (HAL) $35 billion bid for Baker Hughes (BHI)— due to the oil-price crumble and ensuing stock market retreat, which has greatly widened the gap between per-share deal price and the current market price.

In earnings, Abercrombie & Fitch (ANF) beat Street expectations. The news sent its stock, which is down some 40% so far this year, up sharply in early action. The teen retailer logged a loss for the quarter, but its adjusted profit was $0.12 per share, well ahead of the Street’s expected loss for $0.04 per share. Sales fell 8% to $817.8 million, also ahead of an analyst consensus of $812 million. Key metric same-store sales fell 4% in the quarter but were better than the consensus for a decline of 6%.

More good news for the mall? Express (EXPR) jumped in early action after the apparel retailer's better-than-expected fiscal Q2 results and upbeat outlook prompted at least one analyst rating upgrade.

I offered this up yesterday, but it’s worth a repeat: This is market action that calls for small, nimble trades for those who prefer a very short-term horizon; as we’ve preached, don’t go “all in” or “all out” of positions in these conditions. As for those dug in for the long haul, it’s time to refocus on otherwise largely solid fundamentals (and in some instances, prettier valuations) up and down select U.S. stocks.

Good trading,
JJ
@TDAJJKinahan

NC
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