By Pete Biebel, Senior Vice PresidentPrint This Post
The market’s expressway higher took an abrupt detour last week. The averages had motored higher over the previous three weeks, adding significantly to their recovery gains from the March lows, and relegating the February/March sell-off to a just a speck in the rearview mirror. Analysts were declaring a wide-open road ahead as the NASDAQ Composite Index (COMP) crossed above the 10,000 level and reached new record highs. The S&P 500 Index (SPX) came within a couple hundred points of its February high early last week. But, as outlined last week, there were many road signs suggesting that the rally was due for a timeout.
While all the damage was done when the market hit a pothole on Thursday, the timeout began earlier in the week, at least for the Dow Jones Industrial Average (DJIA) and SPX. Following a gap-up, all-day rally on Monday, those averages trended sideways to lower the next two days and gave up all of Monday’s gain by Wednesday’s close. COMP, buoyed by a bevy of big tech stocks, continued higher on Tuesday and Wednesday. Despite that help, COMP stalled at the 10,000 level on Tuesday, then gapped over that level Wednesday morning and, for the first time ever, spent one glorious day in five-digit land.
All the market needed to begin a timeout phase was a good excuse. Thursday morning brought a double-barrel blast of negative news. One shot came in the assessment of FOMC Chairman Powell’s comments the previous afternoon. Analysts apparently concluded, upon further review, that the Fed’s “whatever it takes” approach must mean that the economy is really in bad shape. The second shot was compelling evidence that the rate of new COVID infections had suddenly spiked higher in several of the re-opening states. The averages tumbled on the opening and continued to slide through the day.
And what a slide it was. The session endured relentless selling. The averages sank persistently lower with barely an uptick. Not even the worst of the bad days in February and March had such one-way, all-day action. At the end of the day, the NYSE reported 2,932 declining issues and only 93 advancing issues. That’s got to be some kind of record. In situations when the market has been trending lower for a while, such an extreme advance/decline ratio might signal capitulation and the end of the decline. But when such lopsided market action occurs within a day or two of rally highs, it’s probably a sign that there’s more selling to come.
We shouldn’t be too surprised at the size of Thursday’s downdraft. In recent weeks we’ve called attention to the market’s extreme overbought condition and the presence of excess speculation. As was the case at the February highs, the broad indices were stretched well above any technical danger points. The combination of the gap-up opening on the previous Friday and the gap-down opening on Thursday left a dangerous “island top” on the SPX chart. Perhaps the only thing that prevented a worse performance is that SPX found support at its 200-day moving average near the 3000 level. That level provided support again on Friday as the averages clawed back some of Thursday’s losses.
For the week, COMP lost 2.3%; that was the smallest loss among the broad sectors. That index is still up almost 7% year-to-date. SPX lost a little over twice as much, falling 4.78%, and increasing its year-to-date loss to nearly 6%. The net loss for DJIA was 5.55%; its year-to-date loss is now over 10%. Small-cap stocks were hardest hit; the Russell 2000 Index (RUT) sank about 8% on the week. The best of the U.S equity sectors last week was Technology with a loss of a little more than 2%, no doubt contributing to COMP’s relative outperformance. The Energy sector was at the other end of the list with a loss of nearly 11% for the week.
The big decline was a welcome sight for investors who have been reluctant to chase the market higher. Through late-May and early-June as the averages marched steadily higher, many investors were struggling to balance the fear of being left behind against the fear of buying into a very richly-valued market. To many, last week’s detour may be the opportunity they’ve been waiting for to get back on track. Having been granted this reprieve, some, maybe many investors with sideline cash, will feel an urgency to put a portion of those funds to work. But based on last week’s island top and the extreme bias in Thursday’s trading, it might be prudent to wait a day or two to see if any significant follow-through decline occurs.
There are two specific things you can watch in the days ahead that might impact your decision on how soon and how aggressively to buy. One is whether SPX can hold above the 3000 level and its 200-day average. Sustained trading below that level would likely be followed by an additional decline of 3% to 5%. A second indicator to watch is the ratio of advancing to declining stocks. Just one or two days on which 80% or more of stocks register gains might signal that the timeout has ended, and the uptrend has resumed.
In this sort of situation, one approach that could be considered is to combine any new purchase with a stop-loss order that would close out the trade if the stock’s price declined much further. Set a price maybe 5% to 10% below the cost of the new position as a trigger to cut losses and exit the trade in the event the general market decline continues. Most long-term investors would rarely use a stop-loss. Their buy-and-hold model has little concern for short-term fluctuations. However, in the current volatile, unpredictable market, this approach can make it more comfortable to put some sideline cash back to work.
The rate of increase in new COVID cases is more likely to cause a spasm in the market than any of the economic reports this week. Tuesday’s Retail Sales data and Thursday’s Jobless Claims report could both cause a reflexive twitch, but probably nothing of significance. Friday brings the year’s second quarterly quadruple witching expiration of stock and index options and futures. It will be a day of very high volume but not necessarily big volatility.
|Monday 6/15/2020||Empire State Manufacturing Survey, June||-48.5||-30.0|
|Tuesday 6/16/2020||Retail Sales, May, M/M||-16.4%||+7.5%|
|Retail Sales, less Autos & Gas, May, M/M||-17.2%||+5.2%|
|Industrial Production, Production, May, M/M||-11.2%||+2.9%|
|Industrial Production, Manufacturing, May, M/M||-13.7%||+3.6%|
|Business Inventories, April, M/M||-0.2%||-0.5%|
|Housing Market Index, June||37||44|
|Wednesday 6/17/2020||Housing Starts, May, SAAR||891K||1,100K|
|Thursday 6/18/2020||Initial Jobless Claims||1,542K||1,220K|
|Philadelphia Fed Business Outlook Survey||-43.1||-22.7|
|Leading Indicators, May, M/M||-4.4%||+1.7%|
|Friday 6/19/2020||Quadruple Witching Options & Futures Expiration|
Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.