October Delivered the Market’s First Post-Earnings Reversal of the Rally

Whenever the market sells off, it is good to track whether the selling marks any change in character in the health of the market. Back in June, the change in character was marked by the deepest oversold conditions since March. Those conditions deepened into July and helped provide the fuel for the next strong leg of the rally.

This latest sell-off, has produced oversold conditions even deeper than July’s. That alone is notable. However, one more thing got my attention. This sell-off marks the first time during the rally from the March lows that the market responded to earnings season by trading lower. The first ominous sign was Alcoa’s “gap and crap” after earnings. After making fresh 52-week highs, Alcoa (AA) sold off sharply, ending the day with just a 1% gain. In another two weeks, it was trading below its pre-earnings price. Intel (INTC) experienced a worse post-earnings fade. The list of notable post-earnings fades continues to grow with even favorite stocks such as Apple (AAPL) and Google (GOOG) reversing all their large post-earnings gains on Friday.

If we assume that AA’s earnings kicked off earnings season (an unofficial tradition), then the S&P 500’s pre-earnings price is the close of 1065 on October 8, 2009. The index decisively sliced below that level last Wednesday and went even lower on Friday. This post-earnings reversal is a new thing for the stock market. In April, the reaction to earnings season was very positive. The S&P 500 ended the month 7% higher after AA reported earnings. Supported by deeply oversold conditions, July’s post-earnings response was even better. The S&P 500 ended July 12% higher after AA reported earnings. The decline for October was -2.7%. This is of course a very small change given the scale of the rally from the March lows. Nevertheless, it marks one more change in character in the stock market.

While a more sustained bounce from current oversold conditions is likely sometime soon for certain stocks (I am slowly positioning myself for this possibility while continuing to scan for intra-day shorting opportunities), I am interpreting October’s post-earnings reversal as more evidence suggesting the stock market reached a near-term top last month.

Be careful out there!

Full disclosure: long calls in AAPL and GOOG