By Pete Biebel, Senior Vice PresidentPrint This Post
That’s a line from the song, “Should I Stay or Should I Go?” by a band called The Clash. That song’s title is a refrain that many investors have been repeating over the past several weeks. Thankfully, markets managed to rebound a bit last week with the major averages all gaining about 2 ½%. With that bounce, the “stay or go” question now takes on more significance and hinges on whether the midweek moon-shot rally was just the market’s latest tease or the first leg up in a new longer-term rally.
With the Tuesday/Thursday rebound last week, the market recovered a big chunk of its recent losses. The rally presents an opportunity for those who had “stayed” to now “go” at more favorable prices. If the rebound was just a tease, then now might be a good time for overexposed investors to take steps to reduce portfolio risk. But, what if the downtrend has run its course? What if the rally continues? If the October lows were in fact the end of the downtrend, then now might be a good time to jump onboard as the train is leaving the station.
There are a couple factors that support the bullish case. One is that the major averages all made lower lows early in the week but reversed and ended the week with big gains. That sort of price action is very typical of the final leg in a downtrend. The second positive factor is that we’re coming into a seasonal timeframe that is usually very bullish. The market has a propensity for big drawdowns in September/October that are followed by strong rebound rallies through the final two months of the year.
Unfortunately, there are many factors hinting that last week’s rebound was just a tease in a continuing downtrend. One is that, while the size of the rebound looks very impressive in absolute terms, it was actually just sort of standard in relative terms. In steep downtrends, a little push in either direction can go a long way. Whenever markets have air-pocket declines, they leave a vacuum in their wake that enables big rebound rallies. Some of the steepest rallies on record are snap-back bounces in continuing downtrends.
Both the NASDAQ Composite Index (COMP) and the S&P 500 Index (SPX) recovered about one-third of their declines at last week’s highs. That’s a pretty standard retracement. If those indices can get to the point where they’ve recovered two-thirds of the decline, that would be a much more convincing argument that the downtrend ended at the October lows. Both COMP and SPX still haven’t climbed back above their 200-day moving averages. Until they do, the short-term bias remains lower.
Another factor that taints the veracity of the market’s recent rebound is the doubtful sustainability of strength in the sectors that led the market higher last week. Last week’s biggest winner was the Basic Materials sector. It gained a bit over 6% for the week, but its net loss over the past five weeks is still nearly 7%. The rebound in that group looks suspiciously like a proverbial rally through a vacuum. A quick scan of some of the sector’s individual stocks that were the big winners last week reveals that there may not be much more upside for the group over the next several weeks.
The same goes for the Financials sector. Its 4.71% gain last week was third-best among the U.S. equity sectors. Like COMP and SPX (and the Materials sector), Financials have recovered about one-third of the decline from the summer high. Like the Materials sector, many of the Financials sector stocks had a nice bounce, but most of them have rallied to levels that are likely to see stiff resistance to further advances.
If last week’s rally was more than just a tease, if the October lows marked the end of the correction, then increasing equity exposure would be in order. I think it’s too soon and the risks are too great to make those sorts of moves now. Seeing the averages climb back above their 200-day moving averages (currently about 2765 on SPX) would be encouraging, but the real clincher for me would be seeing SPX back above 2820. That would put it above its 50-day moving average and its mid-October rebound high. SPX rallied to a high of about 2756 last week but ended the week near 2723.
If, instead, there’s more downside to come, then the averages shouldn’t move much beyond last week’s highs anytime soon. Based on the magnitude of the negative momentum at last month’s lows, one or more lower lows are still a reasonable probability. A test of the February/April lows in the vicinity of 2540 seems like a reasonable target. That would represent an additional 7% decline from current levels.
If the prospect of riding out that sort of drawdown creates too much personal anxiety, then now might be a good time to get more defensive. That could be as fancy as using one of several index-based products to create a portfolio hedge or as simple as establishing stop-loss levels on some of your riskier and/or larger positions.
The FOMC’s two-day meeting will begin on Wednesday this week instead of the standard Tuesday. So, the Fed announcement will not occur until Thursday afternoon. No rate bump is expected at this meeting, but analysts will be parsing the Fed’s statement to assess its implications regarding the potential for a December hike. We should expect a fair amount of volatility in response to the Election Day results. As was the case two years ago, the fireworks are likely to begin late Tuesday in the overnight stock index futures market.
|Monday 11/5/2018||PMI Services Index||53.5||54.7|
|ISM Non-Manufacturing Index||61.6||59.4|
|Tuesday 11/6/2018||JOLTS Job Openings||7.136mm||7.100mm|
|Wednesday 11/7/2018||FOMC Meeting Begins|
|Thursday 11/8/2018||Initial Jobless Claims||214K||213K|
|FOMC Meeting Announcement|
|Friday 11/9/2018||Producer Price Index-Final Demand, M/M||+0.2%||+0.2%|
|PPI-FD, less Food & Energy, M/M||+0.2%||+0.2%|
Links to previously published commentaries can be found at benjaminfedwards.com/Company News/Blog/Market.