Trading Slows Ahead of Bank Earnings Express News
An important analyst at Bank of America Merrill Lynch downgraded The Boeing Company (BA) today on increased expectations that returning the 737 Max to the skies will take a lot more than software updates. The news sent the stock down 5% today.
I would argue that the losses were compounded by the fact that Boeing stock reached a resistance level equal to the bottom of the March gap. A so called “dead cat bounce” is a downside gap followed by a brief rally back to resistance and then a fall.
When traders call out a movement as a dead cat bounce, it can become a self-fulfilling prophecy. Most large traders know downside gaps often create resistance levels, so they assume that the risk of another crash after a rally back to the bottom of the gap is very high. Therefore, any negative news that coincides with the “bounce” can have an outsized reaction on traders who were already primed to sell at any sign of trouble.
Unfortunately, Boeing’s losses have an outsized impact on the Dow Jones Industrial Average (DJIA). As I have discussed in previous issues of Chart Advisor, the DJIA is a poor index because it is weighted by share price, which has nothing to do with value. If Boeing has a bad day, it will have a huge impact on the DJIA because it is also the most expensive stock and represents approximately 11% of the DJIA index.
That said, despite the DJIA’s issues, I believe that it still matters because it is so widely watched among retail investors. Almost half of all stocks in the U.S. are owned by individual investors, and if a large percentage of them are only familiar with the DJIA, then poor performance can have an impact on investor sentiment among this critical population.
One bad day caused by a Boeing downgrade isn’t going to create a bear market, but if Boeing were to enter a more serious decline, it could drag on the DJIA for weeks or months. If that happens, investor sentiment could be affected, and the risk of extra volatility will rise.
Boeing is also included in the S&P 500, but because that index is value weighted, Boeing is only 0.85% of the index’s value. This means that the S&P 500 is a more accurate reflection of the total performance of large-cap stocks overall.
The S&P 500 has been slowly moving higher since breaking out on April 1, which is normal behavior. Historically, extended bull trends are accompanied by a proportional decline in the daily trading range. As you can see in the following chart, the Average True Range (ATR) indicator has been in decline since the index retested the inverse head and shoulders breakout on March 26.
While the decline in volatility is a positive sign, the S&P 500 has continued to consolidate within a rising wedge pattern, which could act as resistance in the short term. I would not be surprised to see investors pause briefly while they wait to see how earnings look as the big banks start to report this Friday with JPMorgan Chase & Co. (JPM) and Wells Fargo & Company (WFC).
Risk Indicators – Brexit and the Pound
The major market risk indicators have remained calm since the yield curve inversion last month. This is not to say that there aren’t any signs of weakness, but it indicates that investors do not appear to be pricing in a large adjustment in the near term.
I have been watching the British pound (GBP) for signs of weakness as Brexit continues to be the most significant lurking risk. The GBP has been consistently stable relative to the euro (EUR), as you can see in the following chart. If traders were worried about the two fronts of Brexit negotiations (one between the U.K. and EU and the other within rival factions of Parliament), we should have seen the EUR/GBP exchange rate rise as the GBP weakens.
I will be watching this exchange rate this week for signs of a break higher. Such price activity would indicate a weakening GBP and rising skepticism that the worst-case Brexit scenario can be avoided. Theresa May, the U.K. prime minister, has been negotiating with the head of the U.K.’s Labour Party Jeremy Corbyn on a compromise Brexit plan that will likely be discussed on Wednesday with EU leaders. If the market does not like the progress in either negotiations, we should see it show up in the EUR/GBP exchange rate early.
Bottom Line – Stocks Likely to Remain Flat Before Earnings
Because earnings season is so close to ramping up, traders shouldn’t be overly concerned about today’s slow market. Barring some kind of unexpectedly bad news about Brexit, I expect stocks to remain flat or even slightly negative as prices consolidate within the S&P 500’s wedge pattern and investors wait for the bank reports to get started on Friday and next Monday.
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