By Pete Biebel, Senior Vice PresidentPrint This Post
The contagion news continued to worsen last week, and stocks continued to head south. You’ve probably already heard that it was the single worst week in the market since the Lehman bankruptcy and the worst four-week stretch since November 1929. Where it looked as though the averages might have put in good short-term lows with the reversal on the previous Friday, those hopes were dashed when the market gapped lower on Monday’s opening. I’m not going to spend a lot of time on the gory details. It doesn’t do anybody any good for me to regurgitate a lot of statistics about how much the market has cratered. But, it’s also a disservice to inspire false hope by promising that “It’ll all be better soon.” Nevertheless, I think you’ll find that my comments below are fairly upbeat considering the extent of the recent damage.
In the first week or two of the sell-off, too many people in our industry were too quick to tell us not to worry. It was the sort of advice that had worked for years, but which was, unfortunately, clearly short-sighted in the current circumstance. As the days have passed and the news has grown worse, it has become obvious that no one knows how widespread the contagion might be nor how significant its impact on economic activity and corporate health might be. There’s no reason to expect that the news is going to get any better this week. And as I write this on Sunday evening, the stock index futures are near limit-down with losses of another 4.5%. Yet, at the risk of sounding blindly optimistic, there were several features in last week’s market action that provided some sparks of hope.
As the economic destruction is accelerating, the stock market is beginning to show signs that the worst may be over. Stocks have already discounted a significant hit to corporate earnings. I wouldn’t be surprised if the major averages make a good short-term low this week. I’m certainly not predicting that, but all the important preconditions are in place. Everybody knows we’re overdue for a good recovery bounce. I don’t think there’s any chance that we’ll get back to near the recent highs anytime soon, but, whenever a rebound rally can get going, it should be able to recover a big chunk of the lost ground in a hurry.
One key observation leading to that conclusion is that last week brought the sort of panic selling that is typical of a short-term bottom in a downtrend. As I described over the past few weeks, during the first week or two of the decline, the selling was driven by forced liquidations by risk parity funds, trend-followers, and over-extended market-makers. In discussions with our advisors during that time, they reported very little concern on the part of their clients. The fact that every market sell-off from 2009 through 2019 was a buying opportunity may have created a sense of complacency or overconfidence in investors. That, in turn, may have prevented them from reacting in the early days of the markdown. That all changed last week.
For the first time in a long, long time, our advisors were getting calls from clients in which the primary topic was, “Get me out!” The discomfort and concern that most investors felt over the prior weeks, seemed to have escalated to panic last week. As the news got worse, more and more individual investors felt the need to pull the “Eject” lever. Where the wide-spread, mechanical forced selling in the prior weeks may have had that blood-in-the-streets feel to it, last week’s decline seems to have finally brought a level of individual investor panic that is typical of short-term lows.
Need a few more glimmers of hope to believe that there might be a little light at the end of the tunnel? For one, the market is very oversold on a short-term basis. The averages are way overdue for a snap-back rally. And, last week the market had more back-and-forth action intraday, as opposed to one-way, all-day runs that typified previous weeks. I think that suggests that liquidity is improving, and more traders are willing to step back into the market. Also, as bad as last week was, something around 35% to 40% of last week’s losses in the major indices came from simply giving back the big closing rally that materialized in the last fifteen minutes of trading the previous Friday.
One additional glimmer is the fact that we know at some point the some of the buyers will have to come back. All those risk parity funds and trend-following traders who were forced sellers in the first two weeks of the decline will become forced buyers as volatility declines and stocks rebound a bit.
Three weeks ago, in “Technical Foul,” I wrote, “Last week, the market changed. The corona virus news introduced a whole new level of uncertainty. In such a circumstance, fundamentals go out the window and technical considerations drive market activity.” Through last week, that continued to be the case. The market seems to still be sensitive to key technical levels in the same way that a sleeping cat is sensitive to a cherry bomb.
A key technical level that was apparently in the minds and trading plans of investors last week was the December 2018 low on SPX near 2347. The index fell below that level on Wednesday, probably driven down by the end-of-the-world prognostications of a well-known fund manager on a cable business channel that morning. After breaking the 2347 level, the index dove steeply and briefly traded below 2300 (establishing what turned out to be the low of the week that day) before rebounding and shooting higher in the last half-hour to close a bit above 2400. It looked like a shake-out and reversal through a key level and another opportunity for a good short-term low.
The next day, the market tried to establish a little upward momentum, but SPX stalled in the mid-2400s a few times on Thursday and again on Friday morning. Having failed repeatedly in its attempts to break out, when SPX fell back below 2350 late Friday, it sparked another rush for the exits into the close. SPX ended the day and the week near 2304. At this time, it appears as though SPX will begin trading Monday below 2200. That index should find good support in the 2000-2100 range, so I would expect that the first short-term low in this wave down will be somewhere between here and there.
Two of the hardest hit groups over the past few weeks are the Energy sector and small-cap stocks. The price of Crude Oil, which began the year in the low-$60s, had dribbled down into the low-$40s as March began. Over the past few weeks, a triple-whammy of falling demand, too much supply and a much stronger U.S. Dollar, has cursed Crude with another 50+% decline. It ended last week just below $20 per barrel. The S&P Energy Sector Index has been shredded, falling more than 50% in the past five weeks.
I can think of two specific factors that can explain the underperformance of the Russell 2000 Index of small-cap stocks, RUT. Where COMP and SPX have lost about 30% over the past five weeks, RUT is down by more than 40%. One obvious factor is that most if not all of the component companies lack the financial wherewithal to comfortably weather the coming economic storm. A second reason is that there’s much less depth in the small-cap market. When holders of small-cap funds decide to liquidate, it forces the fund sponsors to sell the underlying stocks whether they want to or not. The small-cap market is just not deep enough to absorb those waves of selling as well as the larger-cap stocks can.
The Consumer Staples and Healthcare sectors have been holding up better than the others, though both are still down 20+% over the past five weeks. Within Healthcare, several of the larger biotech companies and several of the big pharmaceutical companies have displayed the best relative strength.
The upcoming economic data reports are going to be ugly, as in Shrek with a hangover ugly. Worse, no matter how good or bad the numbers might be relative to expectations, there’s no telling how much worse they could get in the weeks and months ahead. Everyone will be watching the daily updates on the number of new cases of infection. Just seeing the rate of increase decline will be a welcome sign. Hopefully, the rate of infections in the U.S. will peak and begin to taper off in the next two weeks. The Initial Claims number on Thursday will be the first of the data points that begins to reflect the impact of the corona virus slowdown.
|Tuesday 3/24/2020||Manufacturing PMI Flash, March||50.7||44.0|
|Services PMI Flash, March||49.4||42.0|
|New Home Sales, M/M||+7.9%||-1.8%|
|Richmond Fed Manufacturing Index, March||-2||-10|
|Wednesday 3/25/2020||Durable Goods Orders, M/M||-0.2%||-1.0%|
|Durable Goods Orders, ex-Transportation, M/M||+0.8%||-0.4%|
|Capital Goods Orders, M/M||+1.1%||-0.3%|
|FHFA House Price Index, M/M||+0.6%||+0.4%|
|Thursday 3/26/2020||Initial Jobless Claims||281K||1,500K|
|Q4 GDP, SAAR||+2.1%||+2.1%|
|Persona; Consumption, Q4||+1.7%||+1.7%|
|Trade in Goods – Trade Deficit, February||$65.9B||$63.8B|
|Kansas City Fed Manufacturing Index, March||5||-10|
|Friday 3/27/2020||Personal Income, February||+0.6%||+0.4%|
|Personal Spending, February||+0.2%||+0.2%|
Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.