Stocks, Bonds, and Indexes: Here Are the Important Levels I'm Watching

Big market benchmarks like the Dow Jones Industrials Average, the S&P 500, and the Nasdaq Composite all tend to go up together, even if they don't always move up at the same pace.

But when markets go down, especially if they go down hard, they all tend to lose at similar rates.

So the secret to being defensive - or profiting from any market plunge - is knowing what's driving the markets and where the important support levels are in benchmark stocks and indexes.

Naturally, as stocks approach those levels, it's a good idea to start setting up your defenses.

That way, if they break those levels, you're free to parlay a potentially ugly downside move into some beautiful profits.

I'm going to show you what the big fish (the institutional investors and trading desks) are keying on now - and what important levels they're watching.

Because if these break, things will get very rough indeed...

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Here's How a Raging Bull Market Could Crash and Burn

If it was possible to strip out all the extraneous influences on stocks and markets, they'd mostly trade off their fundamental metrics like revenue, expenses, margins, cash flow, and capital structure.

All that (and a lot more) comes down to earnings. Earnings are mother's milk to stock investors.

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Earnings have been great lately, so they're not going to bring down the market.

By now, around two-thirds (328) of companies in the S&P 500 have reported their second-quarter earnings. 82% of those have beaten analysts' estimates by 5.3% on average. Year-over-year earnings are up an average of 26.6%

Of course, that's after analysts furiously raised estimates based on tax cuts and better economic growth.

They're raising forward earnings - again! For the remainder of 2018, analysts have raised forward earnings estimates another 10.2% on average.

So it's not earnings that are going to weigh on markets.

Rather, these are the three broad headwinds facing markets:

  • The ability of leadership stocks to continue to lead markets higher
  • Rising yields and signs of real inflation
  • Geopolitics, including potential fallout from trade wars

Going back to the spring of 2009, for as long as the markets have been rallying, tech stocks have been leading the charge higher. There has occasionally been some rotation, where financials might lead for a while - or other sectors, for a quarter or two.

But for most of the ride higher, the "locomotive" has been mega-cap technology stocks like Facebook Inc. (Nasdaq: FB), Amazon.com Inc. (Nasdaq: AMZN), Apple Inc. (Nasdaq: AAPL), Google/Alphabet Inc. (Nasdaq: GOOG), and Microsoft Corp. (Nasdaq: MSFT).

Call them what you want: FANG&MA, FAANG&M, and FANGMA are a couple of handy acronyms making the rounds. Any way you slice it, these companies have been the leadership darlings.

The technical (and more importantly, mechanical) problem markets face is a negative feedback loop -  selling leading to more selling - if those leadership stocks start to decline.

Not only have these leadership stocks been going gangbusters on their own, each of them (with the minor exception of Netflix), weighs heavily in their benchmark indexes.

And when there are several of them in the same index, their combined weight drives performance.

At the same time, lots of ETFs are just loaded with these, which multiplies their already-outsized influence.

In that light, the mechanical problems (which could be triggered by technical breaches if certain support levels are broken) become apparent.

What's more, they become potentially frightening.

The ETF "Apocalypse Factor"

If these stocks decline, first one or two at a time, and then if, as a group, they all start declining, confidence in the group will flounder, and profit taking will weigh even heavier on them.

That's when the negative feedback loop could get triggered.
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And like I said, these leadership stocks are in so many ETFs and mutual funds - mostly index funds sold by the bucketful to supposedly passive investors.

So if the leaders start declining, thereby bringing down the ETFs and mutual funds they're driving, passive investors will get active in a hurry and start selling.

That's a problem for the ETF authorized participants (APs) who manage ETF portfolios, creating and liquidating units.

If sell orders keep rolling in on ETFs, APs must liquidate underlying stocks in the trusts.

As heavier selling catches fire, APs are going to have millions of shares of declining stocks on their hands - stocks that they must liquidate into a falling market.

They'll end up taking huge hits on their own trading desks, so they're going to short stocks and futures to stay ahead of ETF sellers. Their shorting will depress stocks, prompting more ETF selling.

A classic negative feedback loop.

That's why staying attuned to the leadership stocks is so important.

So here's what I - along with every other player on Wall Street - am watching right now.

Pay Attention to These Levels; Be Prepared to Move If They Break

For Facebook, $150 is major support. Of course, the stock just got hammered because of terrible forward guidance by the company's CFO. It's been holding above $172 but could quickly test $170 and break lower.

As a bellwether of social media and advertising spending, Facebook's important to watch.

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Apple's been hitting every pitch out of the park, heading into its first full week of being a trillion-dollar company. But that doesn't mean selling around the horn wouldn't force some profit taking in AAPL shares.

There's support at $190, but more importantly, the $180 level is something of a "line in the sand." If Apple breaks below $180 after all that good news coming out of the company, something's wrong. It certainly won't be Apple's earnings; it'll be negative feedback-loop selling that infects Apple.

Amazon's another super-heavyweight rock star that keeps belting out platinum earnings numbers. But earnings won't be enough in a panic sell-off. The level to watch for Amazon is $1,600. The stock should see buying there.

If it breaks $1,600, the next strong support is $1,400. But getting there in a hurry would be scary. If AMZN shares break below $1,400, it's either a great buy... or we're about to fall into an abyss.

Netflix, at about $337, is fast approaching its major support, which is at the $300 level. While Netflix isn't as big a company as the others, it's watched closely because it's been a stellar performer. A trip below $300 would make a lot of investors very nervous about what remaining profits they have on the table.

Google, after gapping $73 higher to a new record high of $1,273.89 on better-than-expected earnings, has come right back down to $1,210.

If GOOG can hold $1,200, that's a good sign. If it breaks down to $1,175, that's a worrisome sign. The danger zone for Google - and the market - is if the stock breaks major support at $1,100.

Microsoft's been an absolute stellar performer considering it's no longer considered a growth stock. So much for analysts getting it wrong.

I've been recommending buying Microsoft all the way up since it broke $28. Now its support level is $100. If MSFT shares trade below there, it's the market weakening - not Mr. Softy's earnings.

In the world beyond stocks, the news is scary on the interest-rate front.

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Rates are rising in the United States. At least, they're being hiked by the U.S. Federal Reserve. So far, however, the U.S. 10-year Treasury note's been below 3%, a level that when breached to the upside in February spooked investors into a round of panic selling.

Well, we're back there again, though it's not so much the 3% level any more. Markets have digested that level. Rather, the new levels of concern on the 10-year note are 3.10%, then 3.25%.

Now, if rates rise slowly to 3.10% over a few quarters, that's no big deal.

But if the 10-year spikes or gets to 3.10% in a matter of weeks, that's worrisome. If the yield spikes to 3.25% while the stock market's going sideways or meandering lower, it will trigger a bond sell-off that will cross-contaminate stocks in a New York second.

Watch how quickly rates rise - and get out of the way of falling prices in bonds, which is what happens when rates rise - by taking profits on your stocks.

And where would the market be without geopolitics, you ask? Higher, for sure, but geopolitics can't be swept under the rug - especially not trade wars.

Rising interest rates and/or geopolitical "rubber bands" snapping will hit markets and all the benchmark indexes.

The level to watch on the Dow Jones Industrials is 24,000. We need to hold there.

But if we get down to the 23,500 level, that's going to be scary. Breaking that support could seriously panic investors.

For the S&P 500, major support is at 2,700. Below that, something's wrong. The last gasp support for the S&P is 2,550. Below that, and it's "look out below!" - anybody's guess how far down we go from there.

As for the Nasdaq Composite, well, its major support level is 7,400. If the Nasdaq breaks that support and the other benchmarks are breaking down, the Composite's next support level is 7,000.

If we test the Composite's lows at 6,800 and break them, you better hope you're short - and if you're in any of my trading research services, you probably will be.

Those are the important levels all major trading desks and institutional investors are watching; you watch, too.

Make sure you have your stops in place if we start approaching any of those first support level ranges I just mentioned.

If we break them and you've got a bad feeling (and, frankly, you should), load up on your short positions. Because if we get to lower levels and break them, you'll be laughing all the way to the bank.

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About the Author

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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