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Faulty Signals Come to Roost as Market Sells Off

Scott Redler

Yesterday the market closed at new all-time highs, but in the Daily Recap we talked about all of the faulty signals that were starting to add up under the surface. Today, those faulty signals came to roost as S&P and Nasdaq both fell more than 1% on the day. The question is, what will today's sell-off lead to? We have seen the market bounce-back after these types of days several times this year, and traders will be watching closely to see if that scenario plays out again.

Two of the clearest faulty signals for the market that we have talked about all week were relative weakness in the small-cap Russell 2000 index (IWM) and the Transports (IYT). In healthy bull markets, you like to see those two groups leading, and Monday and Tuesday they diverged heavily from the broader markets. Both continued to show relative weakness today, closing down 1.63% and 1.42%, respectively. Today, the indices played a little catch-up to the downside.

In yesterday's Morning Call and Daily Recap, we noted several compelling short set-ups that traders could potentially target. Whole Foods (WFM) was one, and it broke a key support level today on the way to a 1.52% loss.

We talked about the feeling that Netflix (NFLX) and LinkedIn (LNKD) had run out of steam after huge post-earnings moves and were teetering on the edge of upper level support. Both accelerated to the downside today, dropping 3.93% and 3.11% respectively.

The banks as a group have also been weakening more than the broader indices. In particular, we talked about clear short set-ups in Morgan Stanley (MS) and Goldman Sachs (GS), and both broke down today, losing 2.72% and 2.23%, respectively.

Gold (GLD) is not something we targeted as a short set-up, but its weakness is also notable. At times this year you have seen GLD tick up when fear comes into the market, but today GLD followed the market down. Today GLD fell 1.12%, breaking a key pivot support level. The macro pivot support level to watch is around $148.60.

With the market showing so much resilience in 2013, it's hard to pile into short when you see faulty signals or even one day down, but you always have to be on your toes. It has been impressive to see the market shrug off any bad news and continue higher, but I think some of the sector rotation has masked real problems under the hood. As John Darsie mentioned yesterday in the Daily Recap, it feels like risk-reward favors the short side at this stage.

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*DISCLOSURES: Scott Redler is long BAC, FB, S. Short SPY.