Fear Of Outside Influences Fuels Market Pullback

Another week filled with outside stock market influences began with a sharp downturn as negative sentiment let loose a selloff.

Nervousness among stock market participants was born out with the Dow falling almost 700 points and the Nasdaq almost 300 points during the trading day. Traders face a holiday-shortened week with more uncertainty.

Traders should be wary of the uncertainty based on economic news events this week.

All three major indexes down sharply

Traders will have to adjust to a stock market that jumped to an unsettling start this week.

All three major indexes fell sharply and all lost more than 2 percent on the day.

In the market today, the Dow closed at 33,129.59 points to fall 2.06% (dropping 697.10 points on the day). The Nasdaq topped all losses by dropping to 11,492.30 points for a 2.5% tumble while the S&P 500 crumbled 2% to 3,997.34 points.

This was one of the sharpest pullbacks since December of last year.

Traders face rash of economic data releases

Whether the pullback today is a “normal” after-January drop or a more pronounced downward shift is up in the air.

“This shift will be tested as key inflation and economic data will be released,” said Mary Ellen McGonagle, Senior Managing Director of Equities at Simpler Trading.

Federal Open Market Committee (FOMC) meeting minutes from January will be released Wednesday and the January U.S. personal consumption expenditures (PCE) price index, which measures prices paid by consumers for goods and services, is set for release Friday. Both have the potential to set off more selling if the market perceives the data from either as negative.

“Core Personal Consumption Expenditures data for January may be the most impactful,” Mary Ellen said. “This is the Federal Reserve’s most closely watched metric to determine how quickly prices are rising and any number above a monthly increase of 0.4 percent would be a negative.”

Along with these economic news events are U.S. gross domestic product (GDP) numbers Thursday along with the U.S. new home sales and University of Michigan (UMich) Consumer Sentiment Index reports on Friday.

All of these reports, including negative U.S. Consumer Price Index (CPI) and U.S. Producer Price Index (PPI) data from last week give strength to the argument that the Federal Reserve (Fed) will push for higher interest rates next month.

Fed likely to push interest rates higher

Since March of last year, the FOMC has raised its benchmark interest rate from zero to a range of 4.5% to 4.75%. Since the last meeting, central bankers have publicly signaled that more, and possibly higher than the last, increases are still on the table this year.

The central bank’s hawkish interest-rate efforts haven’t tamed inflation which remains elevated overall at more than 6 percent.

A week with this much economic data being released has the team at Simpler Trading cautious about the potential volatility in the stock market.

“Continued weakness in growth stocks which underperform in a rising interest rate environment may push the markets into a more pronounced pullback,” Mary Ellen said. “With this possibility in mind, we would keep the initiation of new positions among growth stocks limited.”

If the economic news plays out better than expected, Simpler’s traders will watch for key signals to adapt to more positive data.

“Our cautious sentiment would shift if we experienced a move back above the 10-day moving average in the Nasdaq on the heels of reduced inflation data,” Mary Ellen said.

Traders follow key market internal signals

With so much uncertainty based on economic news events, Simpler’s traders are watching internal market signals for direction.

Key signals attracting attention this week are the U.S. Dollar Index (DXY) and bond yields.

“I don’t see much edge in overly committing to either side early in the week,” said Sam Shames, Vice President of Options at Simpler Trading. “Regardless of what side of the market you are on, be sure to know where your eject button is and stick to it.”

Another signal Sam is watching is the Chicago Board Of Exchange (CBOE) Volatility Index (VIX).

“VIX likes to break out strongly from falling wedge patterns and there is one in play right now, but no trigger for it yet,” Sam noted. “Keep a distant eye on this, it needs to stay below 20-21. A close above Friday’s high becomes a problem for bulls quickly.”

The VIX bounced higher on Tuesday, closing at 22.96, up more than 7.5 percent from Friday.

For more on how the team at Simpler Trading is working this market environment, check out the day trading room.