Like the previous day, the S&P 500 surged higher in the morning, briefly penetrating the upper channel resistance of its three-week trading range, but quickly reversed and fell back down. This time, however, stocks sold off sharply in the final hour of trading, rather than drifting sideways into the close. The Nasdaq Composite slipped 0.5%, as the S&P 500 and Dow Jones Industrial Average registered identical losses of 0.8%. The small-cap Russell 2000 and S&P Midcap 400 indices declined 1.2% and 1.0% respectively. For the first time in weeks, all the main stock market indexes closed at their intraday lows.

Total volume in the NYSE rose 10% above the previous day's level, but turnover in the Nasdaq was 3% lighter. The losses on higher volume in the NYSE caused the S&P 500 to register a "distribution day," indicative of institutional selling. The slower trade in the Nasdaq enabled the index to dodge the same bearish label. Market internals were relatively neutral throughout most of the day, but rapidly deteriorated as stocks sold off into the close. In the NYSE, declining volume exceeded advancing volume by a ratio of 5 to 2. The Nasdaq adv/dec volume ratio was negative by approximately 2 to 1.

We found yesterday's price action to be rather interesting for one primary reason: the stock market has apparently started reacting negatively to positive news. After Wednesday's close, Bank of America (BAC) surprised Wall Street by announcing their intention to repay their entire $45 billion TARP loan from the government. This initially caused a positive reaction in the financial sector, as nearly every banking and brokerage stock opened sharply higher in yesterday's session. However, the encouraging news out of BAC was soon to be ignored, as traders sold into strength of the upward gaps. By day's end, the financial sector had not only surrendered its intraday gains, but was bleeding deep in the red as well. The Regional Bank HOLDR (RKH), which we have been short for the past several weeks, plunged 3.0%. Yesterday's swift change of intraday sentiment in the financial arena can be seen by taking a look at the 15-minute intraday chart of RKH:



On the open, RKH traded to its highest price since November 12, the day of our entry into the short position. But the recent relative weakness in the banking sector prevailed, causing RKH to abruptly turn tail. After the first hour of trading, RKH had already fallen back to the unchanged mark, but the selling persisted and intensified as the session progressed. In the early afternoon, RKH sliced through support of its previous two days' lows, causing downside momentum to intensify. By the closing bell, straddled with a 3.0% loss, RKH finished just above critical support of its November 27 "swing low." Looking at the more significant daily chart of RKH, notice that yesterday's opening gap was right into resistance of the 50-day moving average. As you can see on the daily chart below, the 50-day MA also stopped RKH dead in its tracks back on November 11:



Because the financials are so heavily weighted within the broad market, we view yesterday's incredibly bearish performance of the sector as a key warning signal to the bulls. The same was true of the CBOE Volatility Index ($VIX) coming into support of the 20 area, which we pointed out in yesterday's commentary. As long as financials are dead, it will be very difficult for the S&P and Dow to make much upward progress, although strength in the Semiconductor Index ($SOX) may enable the Nasdaq to do so.

More important than yesterday's failed gap up and sell-off in the financial industry is the fact that the market sold off in the face of good news. A very reliable sign of a bullish environment comes from a market that moves higher on bad news. Conversely, it's bearish when a market moves lower on the announcement of positive news. While the financial sector may have had every opportunity to zoom higher on the encouraging news out of BAC, it fell apart instead. Frankly, this is the first time we remember in quite a while that the stock market not only didn't zoom higher on bad news, but actually sold off on seemingly positive news. We view this is a subtle, yet very important, sign that overall market sentiment may be shifting in favor of the bears.

As for the broad market, the S&P 500 has started to close the opening gap of December 1. If the gap is filled and the index continues lower, next stop would be support of the November 27 and November 30 lows, the former of which marks the lower channel support of the three-week trading range. At that point, it would be time to close or lighten up on any short positions, and consider getting long again. Until the market proves otherwise, one must assume the S&P 500 will continue to oscillate between support and resistance of its sideways trading range that has been intact for nearly a month. Selling long positions and/or putting on a few shorts near the high of the range, combined with getting long and/or covering short positions near the lows, is a relatively low-risk way to manage your portfolio in a non-trending environment. Presently, our model ETF portfolio has two long positions and two short positions. Right now, both short positions are working out very well, while the long positions are holding their ground and serving to lower overall market risk.

Open ETF positions:

Long - IBB, FCG
Short (including inversely correlated "short ETFs") - RKH, OIH

Deron Wagner is the Founder and Head Trader of both Morpheus Capital LP, a U.S. hedge fund, and MorpheusTrading.com, a trader education firm.