S&P 500 Declines Almost 70 points in 3 days. Will the Bloodbath Continue?

As expected, the Fed didn't announce a reduction in QE, but Bernanke did say there was still a possibility the Fed could start tapering its asset purchases later this year. The markets sold-off pretty much any and every asset class in response.

This sell reaction was stronger and more immediate than I expected. If Bernanke and the Fed were trying to gauge what type of psychological effect that the idea of reducing asset purchases would have on the market, I think they just received a rather rude answer.

Whether the selling was directly in response to the possibility of the Fed tapering before the end of the year or if it was just an excuse to push down an overbought market, the reaction was irrational in my opinion. I had actually speculated that we might see an initial response of buying that would follow the Fed announcement, but it never happened. There was no fake-out to the upside, the selling started immediately and hasn't really let up.

While price action is bearish, I do not expect the selling to continue without at least a solid bounce to the upside first. I unfortunately got stuck in a long position that has yet to give me the right opportunity to exit. Because I believe the market will reflect on the last few days of irrational selling with a rational frame of reasoning, I continue to hold my long entry in anticipation of a bounce. Friday's rebound off the lows signals that there should be additional room to move to the upside. I will look to sell 1/2 my position with a move back above 1600 on the ES.

In my last post, I mentioned a potential bottom of any correction in the 1555-1565 range on the ES (U13). That price range is not far away so it is very possible the ES trades down to my key support before we get a decent bounce. I do expect to see buying come in before that happens, we'll have to wait and see.

Bonds
I've spoken about bonds on a few occasions in the past weeks. Each time, I was looking for support to come in and each time support has been broken. Bonds have now traded lower than the most critical support level at 110 on the TLT. This break of support was not only the 3d break of a possible support level in the last month, it was also on very high volume. This is a high odds indicator of capitulation. It will be important to see a daily close back above 110 (TLT) on Monday to gain confidence in the likelihood of a reversal.

Gold
Fear of tapering by the Fed has also sent the price of Gold lower. While the price action in Gold remains bearish,  I will be watching for a capitulation type move somewhere in the 1150-1250 price range on the YG (Q13 Gold Futures Contract). I will strongly consider  buy entries when that happens.

The bottom line is that fear is rampant across most asset classes and when fear grips the minds of market participants, its often the time to take the reverse bet. I'm not suggesting to get bullish for any extended period of time, but I expect positive price action in the near-term.

Levels to watch on the ES (U13 Sept Contract):
Resistance above at: 1596-1597, 1601-1602, 1611-1612, 1618-1619, 1623-1624
Support below at: 1570-1571, 1565-1566, 1557-1558, 1554-1555

Market Bullish Ahead of the FOMC Announcement

The immediate-term price action is quite bullish and I wouldn't be surprised to see the ES approach or even retest the May highs. In the bigger picture however, I see the market in a topping pattern and that keeps the bearish outlook alive. I do expect to see lower lows as we trade into the summer.

As I write this and the ES trades near 1645, I am more or less neutral. I will be watching the market reaction to the FOMC announcement today (2.00 pm EST) and the press conference with Ben Bernanke (2.30 pm EST).

Expectations:
Fed will not taper. $85 billion in asset purchases will continue.

The catalyst that started the selling back on May 22nd, was the comment by Ben Bernanke who said, "If we see continued improvement and we have confidence that that's going to be sustained, then we could in the next few meetings ... take a step down in our pace of purchases." 

Since this taper comment, Japanese stocks traded down as much as 20%, emerging markets were down 10% and the S&P 500 was down 5%. All this because Bernanke suggested the Fed will create less than $85 billion dollars per month at some point. But lets get real, the Fed is not going to do this any time soon. $85 billion per month in asset purchases will continue and here is why:

• Unemployment rate has not reached Fed target of 6.5%
• Inflation levels remain subdued. 
• The Fed balance sheet is excessive, it has been excessive and it will continue to be excessive. Tapering will not change this.
• The price of Treasury Bonds is approaching important support levels. The Fed does not want to see selling in treasuries continue at this point. Bernanke will make sure this does not happen. This alone guarantees (in my opinion) that the Fed will not taper at this time.
• Industrial and tech companies need to see an economic recovery in the developing world in the 2nd half of the year. Tapering is not the answer and without a recovery in the developing economies, a world wide economic slow down could ensue.

So what does that mean for equities? I really don't think it means much. Continuing to add $85 billion of liquidity into the markets is enough to prevent sellers from reeking havoc on the markets, but it isn't enough to to surge the markets to new highs from here. We have already seen equities bid up ahead of the FOMC announcement, so some of the bullish sentiment that comes along with continued easing, is already priced in. If the Fed does happen to reduce asset purchases (or taper), you can expect heavy selling to commence. Like I said earlier, this is a very unlikely scenario at this time. 

The market remains elevated (ES is up 23% since November 16th of last year) and price action over the past month continues to signify a potential topping pattern. It would take a surprise increase in the level of asset purchases by the Fed to sustain this remarkable bull market without seeing a more significant correction first.

We'll see what kind of language we get from Bernanke. There is still room for the market to move a little higher before more sellers come back into the picture.

Levels to watch on the ES (U - September 2013 Contract):

Resistance above at: 1655-1656, 1659-1660, 1664-1665, 1674-1675

Support below at: 1635-1636, 1629-1630, 1607-1608, 1592-1593.

Looking further ahead, I am expecting a bottom in the 1555-1565 range. But we'll listen to what Ben has to say before getting too ahead of ourselves...

Potential Bottoming Action

Market action remains bearish overall, but the ES showed signs that it may be bottoming in the short-term. The ES made another new low yesterday as it broke through the 1600 level on high volume. The sub-1600 price action was short-lived as buyers quickly stepped in and pushed price back in the opposite direction. I am neutral in the immediate-term with a slight bias to the upside. This means I will consider buying dips as we close the week. A move down to 1605-1607 will be an attractive price-point to consider long entries. That could lead to a 25-35 point trade to the upside, at which point I will be looking to sell the market again.

I exited my short position.

Levels to watch on the ES (M June 2013 Contract):
1632-1633, 1642-1643, 1650-1651
1605-1607, 1601-1602, 1595-1596, 1585-1586

The Bearish View Remains

I waited all of last week for the bearish price action to confirm and it finally did on Friday as the ES (M13 June Contract) made a new low at 1626.25, one tick above the key support level mentioned in my last post.

Price action remains bearish this week as we have seen lower lows. I expect further downside and continue to prefer selling rallies.

Will continue to hold my short position.

Levels to Watch on the ES (M June Contract):
Resistance above at: 1633-1634, 1647-1649, 1667-1669
Support below at: Just watching the 1607-1612 price range for now.