SPY opened strong and closed weak for the second time in two days. Another long red candlestick formed as the ETF closed below its late November low. Even though SPY broke support, keep in mind that the last true reaction low was in early November around 103 and SPY remains close to the 62% retracement mark. "True" reaction lows occur after pullbacks. The late November low formed as part of a consolidation within a bigger advance (early Nov to early Jan).
After the sharp decline from 115 to 107.5, SPY is once again short-term oversold and ripe for some kind of bounce or consolidation. First, notice that SPY is still near the 62% retracement and support from the late November low. Second, notice that 5-period RSI is oversold as it moved back below 30. An RSI break above 35 would argue for an oversold bounce that could retrace 50% of the January decline.
On a percentage basis, this is the sharpest decline since June-July. SPY was down around 7.5% in four weeks for the June-July correction, which was a zigzag pullback. SPY lost around 5.5% during the October correction, which was a short-sharp pullback. With another loss on Friday, SPY is currently down around 6.5% with a sharp decline over the last two weeks.
Even though a breakout would reverse the short-term downtrend, a pullback and support test is quite possible after the first surge. In other words, we could see a clear breakout at 110.5 and then a pullback to retest support in the 107.5-108.5 area.
Looking ahead this week, earnings season remains in full swing with over 400 companies scheduled to report this week. Earnings reports have been good overall, but we are seeing a buy-the-rumor and sell-the-news scenario. The advance into earnings season priced in this good news and traders/investors are now taking profits. The economic calendar is also full with the big employment report scheduled for Friday before the open. We will get an employment preview with the ADP Employment report on Wednesday before the open and Initial Claims on Thursday before the open.
