NEW YORK (TheStreet) -- If you have been trading the markets the last couple of months you have probably recognized that something doesn't seem right. If you traded these markets last week, then you really know something doesn't seem right.
The large swings last week were uncanny. It is assumed that the massive swings we saw are a day traders dream, but I wouldn't be so sure as they were fairly hard to navigate. The end result though was about a 53-point move in the S&P 500 Index
Underneath the Surface: We have recently had multiple distribution days (down days on heavy volume), but no recent accumulation days (up days on heavy volume) so one could speculate that the rallies on lighter volume are being used by large institutions to sell into. The facts are that the discretionary sector is still underperforming, while the sectors considered more risk averse such as utilities are outperforming.
Although all of this sounds ominous (and if you are actively trading it feels ominous) I'm still of the belief that this is all part of a healthy correction within a bull market. After a five-year bull run, it makes sense that we pause and digest the enormous gains that have come since the 2009 bottom. The implications of that are more volatility, mean reversion, and more realistic valuations as opposed to momentum being the primary driver. Put another way, fundamentals will now start to matter.
So What's Next? The truth of the matter is nobody knows, but I would assume the volatility, at least for the rest of 2014, is here to stay. I am of the belief that the S&P 500 will visit the 200-day moving average (MA) in the not to distant future. Whereas before I assumed that meant a decent sized correction, I am starting to wonder if perhaps all these price swings are 'buying time,' in that they are allowing the 200-day MA to catch up so that the two shall meet under circumstances that don't necessarily result in a large correction or crash type scenario. This would then be referred to as a correction through time rather than price (but to short term traders might not feel so smooth). We saw a lot of that last year, but on a shorter time frame. Perhaps 2014 will end up as an entire year of correcting through time. If that is the case then investors will have a stale year, but traders if they play it right can greatly benefit.
Are Recent Earnings Reactions a Sign of Weakness? One thing we have seen, albeit still with a very limited sample size, is how earnings reactions are panning out. International Business Machines Corporation (IBM), which did not beat both top- and bottom-line expectations fell 3.3%. Google (GOOGL), which also missed street expectations, but reported a fairly decent quarter fell by 3.7%. Chipotle Mexican Grill (CMG) which beat street expectations, gapped higher but then fell about 6% intraday.
One could make the case that if this has happened last year GOOGL would have been given a free pass as investors would have realized the value there is still very much intact. Moreover, they may have taken CMG earnings at face value and as a beat taking the stock higher rather than taking a deeper look at CMG's future and high valuation relative to its sector. The next two weeks we will see many high flyers report such as Netflix (NFLX), Amazon (AMZN), and Apple (AAPL). Accessing their reactions will be a big clue regarding the risk appetite of the current market.
Looking Toward Next Week: If you look at the S&P 500, it will appear as if we had a very minor pull-back and are in the stages of another V-shape reversal back to new highs. However, if you look toward the indexes that better represent a risk-on environment, such as the PowerShares (QQQ), which tracks the Nasdaq 100 Index and the IShares Russell 2000 (IWM), which tracks the Russell 2000 Index, you will see a completely different story where the damage is still very prominent. Also, if you take a look at the charts below you will see that during the previous pull-backs that I marked, the damage prior to 2014 seems more muted in the Nasdaq 100 and the Russell 2000 compared to the S&P 500, whereas this time it's the opposite. Perhaps in fact "this time is different."
It's very difficult for me to imagine that given the recent large daily swings, the underperformance of the discretionary sector relative to utilities, and the lack of fear among investors that we will see such a dramatic upswing next week taking us back to new highs. The factors that I mentioned last week here regarding signs that I look for to help me determine when the current correction is over never presented themselves fully. Namely, we never got to the oversold levels I believe present a wash-out and fear, based on the put/call ratio and the CBOE Market Volatility Index (VIX.X) still show a fairly complacent investor mentality.
I think the best strategy for next week is to focus on what is working, such as the energy and utilities sector, to look for possible shorting opportunities should we roll back over and perhaps to begin to dabble into some beaten down and oversold biotech names that still have sound fundamentals. Important levels of S&P 500 support next week are near 1850, 1815, 1795 and 1765. Important levels of resistance are 1872 and 1897.
At the time of publication, the author held no positions in any of the stocks mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.