Trade Talk Stalemate Could Turn Short-Term Sellers into Longer-Term Bears

The major U.S. equity indexes posted a volatile two-sided trade last week before finishing lower for the week. Equities were pressured from the get go last Monday, hitting their lowest levels since late March, before mounting a strong recovery that drove prices to their highest levels in a week.

Although the indexes did manage to find support early in the week, the buying still looked tentative. Technical traders called the mid-week rally a “dead cat bounce’. Some analysts said the move was generated by value buyers. Others said it was just profit-taking and short-covering due to hope of a US-China trade deal.

By the end of the week, prices had retreated some on the news that trade talks had stalled. With this development hanging in the air over the week-end, investors are anticipating a lower opening on Monday.

In the cash market last week, the benchmark S&P 500 Index settled at 2859.53, down 0.8%. It’s up 14.1% for the year. The blue chip Dow Jones Industrial Average finished at 25764.00, down 0.7%. Its gain for the year is 10.4%. The technology-based NASDAQ Composite closed at 7816.29, down 1.3%. Despite two weeks of selling pressure, it’s still up 17.8% for the year.

Secondary Lower Tops May Be Signaling Return of Short-Sellers

Last week’s price action demonstrated just how sensitive investors have become to trade news. Choppiness was the primary theme throughout the week. Some investors are even saying trying to predict the short-term moves is just a coin-toss with some news expected to be positive and some negative as the two-economic powerhouses try to hammer out a deal.

Friday’s price action in response to the news that the trade talks had stalled could set the tone for this week. We’re going to be looking for signs of a shift in investor sentiment. If a bear market is going to develop then it should start to emerge this week.

The first break of any bear market is usually long liquidation. We saw that two weeks ago. Then following a 50% to 61.8% retracement of the first break, new shorts will show up and the next break should be a doozy. This is what we may have seen last week. If the retracement zones that were tested last week turn into resistance then look out to the downside.

Professionals rarely sell the top, but like the current top formation, many are caught by surprise news and just start dumping stock, leading to the first sell-off. Seldom do professionals sell weakness either. So they wait for a retracement of the first leg down. It’s this move that usually attracts the new short sellers.

If fresh short-sellers started to emerge last Thursday and Friday then look for early pressure this week. If last week’s lows fail to hold as support then the next leg down could be as much as two times the size of the first break.

For the June E-mini S&P 500 Index, look out to the downside if 2880.50 to 2899.50 holds as resistance. The June E-mini Dow Jones Industrial Average’s key resistance is 25955 to 26129 and the June E-mini NASDAQ has resistance at 7584.75 to 7654.25.

Trader Psychology

During the first two weeks of the return of heightened volatility, the up and down swings were short and sweet because traders continued to bet on a quick resolution to the U.S.-China trade dispute.

However, if the U.S.-China trade talks have indeed stalled as reported late Friday then investors are going to start pricing in a longer stalemate and this will likely mean more long liquidation and fresh short-selling.