Stocks Must Go Down To Go Up

On Tuesday the S&P 500 futures [CME:SPM14] closed down 14.2 handles lower or -1%. The day started out on a good note with the S&P making an early high at 1880.70. The overall tone of the selloff was mainly index arbitrage sell programs and sell stops. Tuesday’s decline saw U.S. stocks fall over 1% since the Dow and S&P hit new record highs on May 13.

Patterns

No one knows when the patterns will change, but with the U.S. economy accelerating we don’t think it will be anytime soon. The basic pattern is for the S&P to make new highs, pull back and then trade higher again.

This pattern tends to accentuate our trading rule called “thin to win.” When 1 million or fewer contracts of the E-mini S&P futures ESM trade, the S&P is generally going up.

Overnight, the Asian markets closed mostly lower, and in Europe 8 out of 12 markets are trading lower. Today’s economic calendar starts with the MBA purchase applications, New York Fed President William Dudley and New York Fed economists hold briefing on regional job gains and economic conditions, and the EIA petroleum status.

Federal Reserve Chair Janet Yellen delivers a commencement address to NYU at Yankee Stadium, Kansas City Fed’s Esther George speaks in Washington on the U.S. economy and banking, Minneapolis Fed’s Narayana Kocherlakota speaks in Minneapolis, and the FOMC minutes are released. Expect earnings from Hormel Foods (NYSE: HRL), Target (NYSE: TGT), Lowe’s Companies (NYSE: LOW), and L Brands LB.

Our View

Federal Reserve chair Janet Yellen speaks in New York and the U.S. central bank will release the minutes today. We don’t expect any any clues on when the Fed may raise rates. What we do expect is another day of choppy trade.

Our view is that the ESM14 is still range-trading; we lean to selling the early rallies and buying weakness. All the S&P is doing now is getting people short into the decline and when the ES goes back up it will be with the help of those short sellers and their buy stops.

As always, please keep an eye on the 10-handle rule and please use stops when trading futures and options.

• In Asia, 7 of 11 markets closed lower: Shanghai Comp. +0.84%, Hang Seng +0.01%, Nikkei -0.24%.
• In Europe, 8 of 12 markets are trading lower: DAX +0.26%, FTSE +0.08%
• Morning headline: “Stock futures up ahead of FOMC minutes”
• Fair value: S&P -2.92 , Nasdaq -2.25 , Dow -2805
• Total volume: 1.56ESM and 8.1k SPM traded
• Economic calendar: MBA purchase applications, William Dudley speaks, EIA petroleum status, Janet Yellen, Esther George, Narayana Kocherlakota speak, FOMC minutes. Earnings from Hormel Foods HRL, Target TGT, Lowe’s Companies LOW, and L Brands LB.