Will the Tactical Guys Blow Up the Market on Monday?

The S&P 500 just broke its 200-day moving average on Friday, a major development technically as many believe that the market above its 200-day is safe to own and in accumulation mode while a market that sits below this measure of supply and demand is in bad shape and cannot be owned.

I nicked the below screenshot from my friend ZorTrades (via Chart.ly) and then I annotated it a bit:

Mark Hulbert at MarketWatch believes that this major trendline break could portend “an avalanche of selling” when the market reopens on Monday morning as managers honor their sell discipline and get the hell out.  He warns us about the potential damage that could occur as so many hit the exits at once:

Though the market doesn’t always fall off a cliff upon breaking the 200-day moving average, that certainly is what happened the last time the market broke this key technical level.

That occurred last Aug. 2, on which day the S&P 500 closed at 1,251.46. At its intra-day low just one week later, on Aug. 9, the S&P stood 150 points lower at 1101.54—an extraordinary decline of 12% in just five trading sessions.

I remember that last occurrence well, Barry had us blow out all kinds of stock exposure on that morning for clients (which coincided with the debt ceiling debacle and resolution over the prior weekend).

So will Monday bring another episode like that one, with the avalanche of sellers and attendant wipeout for the indices?

I suppose that depends on the following factors:

1.  How much money is really run tactically these days?  Are the majority of market-moving managers (big guys with big positions) really that nimble?  Or do they mostly sit tight and just keep buying their favorite stocks no matter what happens?

2.  How much money is really run based on technicals these days?  My friend Scotty V runs an RIA firm in Sacramento CA and his model strategies employ the use of the 200-day (to the best of my recollection) as a primary risk management line in the sand.  My other friend Scott, also an RIA firm in Cali, has a similar discipline for his client accounts.  And I’m certain you’re all familiar with my pal Mebane Faber, the brilliant author of The Ivy Portfolio and the white paper that spawned it, has done a great deal to popularize this particular tactic with his work on the ten-month moving average (similar to 200-day) as buy or sell signal.

But these are RIA firms and active ETF managers I’m referring to – do pension funds and mega mutual funds give a shit about risk management in real life and do they even understand what a moving average is?  It occurs to me that they are way more focused on fundamental research and stockpicking than they are on price, market behavior or macro trends.

3.  Leaving aside the question of whether or not that many US market participants are well-versed or even interested in technicals or tactics, what if the breakdown Friday turns out to be a “false move”?  My friend JC, one of the best technicians I’ve ever known, has a favorite setup based on the maxim “from false moves come fast moves” – essentially when all the chart guys see the same thing happening and then its a head fake, that rush on everyone’s part to switch sides (short-covering, selling, buying etc) causes a freight train-like explosion in the opposite direction.

4.  Also, with sentiment in the gutter, what if the headlines catch everyone off a guard?  A major stimulus plan from China’s central government?  Could mean an explosion in cyclical stocks and commodities.  What about a German pronouncement about softening their stance on austerity or a willingness to provide universal deposit insurance in a bid to end the peripheral bank run?  Could happen you know, and if it did, you could basically throw your moving averages in the garbage, it will be a risk-on free-for-all, at least in the short-term.  What if the ECB signals a 50 basis point cut or one of our own Fed Heads confirms the resumption of Operation Twist?  What would headlines like that do for a tae that is widely acknowledged to be, at best, dead money?

So yeah, the trendline break below the 200-day is kind of a big deal.  The S&P is the big show, the one that really counts.  But the question of whether or not it will really have the impact on Monday that some expect is not quite so simple.  Because other than the blogosphere and a handful of prop traders and RIA portfolio managers, I’m not convinced that anyone else will notice.

Sources:

Watch for Avalanche of Sell orders Monday (MarketWatch)

The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid bear Markets (Amazon)