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Cisco Systems, Inc. (CSCO), Wal-Mart Stores, Inc. (WMT): Market Outlook, Short the Market If This Happens

By some measures, stocks just suffered their worst week in 2013. Despite that setback, the S&P 500 is less than 3.2% from its all-time high. Until prices fall further, the weight of the evidence shows stocks are still in a long-term uptrend.

SPY Nears Support

SPDR S&P 500 (NYSE:SPY) fell for the second week in a row, losing 2.06% last week. Other major market indexes were also down as traders reacted to news that was generally considered to be negative. Among the most important news stories was that a number of companies, including Cisco Systems, Inc. (NASDAQ:CSCO) and Wal-Mart Stores, Inc. (NYSE:WMT), lowered their outlook for the rest of the year.

*See how hedge funds are playing Cisco and how they’re betting on Wal-Mart

Even good news was bad news to traders last week. Retail sales exceeded expectations, and the number of initial unemployment claims fell to a six-year low.

The problem with good news is that the Federal Reserve has said they will taper their buying and eventually stop purchasing $85 billion worth of long-term bonds every month when unemployment declines sufficiently. Traders are concerned that the market could fall if the Fed stops buying long-term bonds.

Continued good news about the economy could be the cause of a stock market decline.

For now, SPY seems to be near a level where it should find support. The chart below shows a small head-and-shoulders pattern. The “S” on the left side is the first shoulder in the pattern. This forms when prices pull back after trending higher. The “H,” or head, is the new high reached after the initial pullback. The “S” on the right is the second shoulder, which forms after a rally fails to reach a new high. The pattern could be labeled differently, but the general idea is the same for any type of topping pattern.

SPY Chart

Almost all chart patterns use the idea of symmetry to find price targets. The eventual breakout is expected to be equal to the size of the pattern. In this case, the distance between the bottoms of the shoulders and the top of the head is equal to about $3.50. This value is subtracted from the breakout point and a target of $164 is drawn on the chart above.

The next chart shows that a similar target can be found with another technique.

SPY Market Outlook Chart

After a price move, technical analysts look for a retracement. Markets never move straight up or down, and a retracement generally occurs after a significant increase or decrease in prices. At $163.35, SPY would retrace half of the move that pushed prices up from late June to early August.

A break below $163 would show that we exceeded a normal pullback and more downside should then be expected.

Good news for the economy will support growth in earnings, and that should push stock prices up in the longer term.

I still believe that the S&P 500 will reach 2,000 in the next 6-12 months. Long-term investors should not be concerned about the recent weakness in stock prices. Short-term traders should consider adding inverse ETFs like ProShares Short S&P 500 (NYSE:SH) to their portfolio if SPY falls below $163.

Gold Market Faces Less Selling Pressure

SPDR Gold Trust (ETF) (NYSEARCA:GLD) gained 4.51% last week. This gain came as SEC filings showed that large hedge funds reduced their positions in GLD during the second quarter.

John Paulson sold about 11.6 million shares, worth at least $1.3 billion. George Soros also sold his position in GLD, although it was much smaller than Paulson’s at about 500,000 shares. These two investors were joined by a number of other investors who sold in the second quarter when the total outflow from GLD was $18.5 billion.

According to some reports, Paulson has not turned bearish on gold. He sold the ETF and bought derivatives in gold.

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