Why You Should Worry About A Short-Term Pullback

Friday brought good news about the economy. Let’s check it out.

The unemployment rate fell to 10.2% in July, down from 14.7% in April. In the month, employers added about 1.8 million jobs.

A detailed look at the report showed that the job gains were broad based.

Source: CNBC

However, traders didn’t seem very impressed by the news. The intraday chart of SPDR Dow Jones Industrial Average ETF Trust (NYSE: DIA) below shows a lower opening followed by a rally at the end of the day. All in all, the Dow managed to eke out a gain of 0.17%.

Now, one possible reason we didn’t see a bigger reaction is because traders spent much of Friday taking profits. Despite the lackluster results on Friday, the broader market turned in some nice performances for the week:

The Dow gained 4.26%.
The S&P 500 rose 3.14%.
The tech-heavy Nasdaq Composite climbed 4.00%.

Even small caps participated in the rally, with the Russell 2000 adding 4.73%.

Friday’s Action Could Indicate Traders Are Concerned…

The market action we saw at the end of last week could indicate that traders are worried the market has moved up too fast.

Traders are increasingly concerned about the coronavirus. This can be seen in the next image which shows the five most popular articles on the financial website MarketWatch.com.

Source: MarketWatch.com

Four of the five are about the virus. None are about the stock market or personal finance. This concern comes as the recent surge in new cases appears to be leveling off.

Source: NYTimes.com

Data on the virus is discouraging for the economy. In response to the surge, many states and cities re-imposed restrictions. These steps could slow the economy… and even after the employment gains, the economy is still struggling.

Source: Federal Reserve

This chart shows the number of people employed compared to a year ago. After July’s gains, there are still 11.4 million less jobs than there were in July 2019.

The Short-Term Picture

Unemployment and coronavirus are long-term concerns. I’ll wrap up with a look at the short term.

My last chart is a weekly look at the S&P 500.

In the past two weeks, the index closed less than 10% from the high for the week. On average, we see this pattern about twice a year.

Closing near the high at the end of the week shows traders are willing to carry risk over the weekend. This happens when traders are unusually bullish, wanting to get into stocks before they race higher. This pattern shows that sentiment is at an extreme.

The blue rectangle on the chart shows the last time this pattern occurred, toward the end of last summer. As you can see in the image, we usually experience weakness in the weeks after this pattern forms.

History tells us to be cautious in the short run because traders are unusually bullish. Trends in unemployment and the coronavirus are warning us that we should be cautious in the months ahead. [Related: Why Traders Should Focus On The Short-Run Right Now]

The bottom line is that I expect a short-term pullback, and we should watch that closely to determine whether the bear market that began in March is over.

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