By Pete Biebel, Senior Vice PresidentPrint This Post
The road to wealth, for most of us, is not a quick blast down the freeway of high finance, but a bumpy, winding path that yields steady long-term progress sprinkled with occasional inconvenient detours. We know that with discipline and planning, we have a better chance of reaching the destination in the long run. Yet, we also know that the longer the periods of peaceful, easy cruising we enjoy, the greater the odds of an eventual, temporary, disheartening diversion. The past three months have been one of those diversions.
A glance in the rear-view mirror quickly confirms that, despite the recent reversal, we’ve made quite a bit of forward progress over the past 9 ½ years. And, in that time, we’ve had surprisingly few diversions. The S&P 500 Index (SPX) climbed about 340% from March 2009 to September 2018. Over that stretch, there were only a couple times that the market took the long way around to get back on track. During the summer of 2011, after the index had doubled in the previous two years, SPX lost about 18% from peak to trough. Six months later, the index was making new highs. From mid-2015 into early-2016, after SPX had gained more than 50% beyond the 2011 high, the index sank about 15% (peak to trough) in about four months, and 13 percentage points of that decline came in just the first few weeks that January. Five months later, SPX was making new highs. From that new high in 2016, SPX tacked on another 35% or so to reach its October 2018 record high. Not a bad ride.
Here’s my assessment of current conditions…
- The worst is probably over.
- The odds of at least one lower low are still pretty strong, but that low will probably not be worse than another 4 to 6% lower.
- Volatility is likely at or very near a peak. Expect volatility to gradually subside to more traditional levels into late-January and February.
- Many stocks seem to already have declined to bargain prices, but the current negative momentum suggests that there’s no rush to buy.
- Economic conditions are pretty good, but growth is slowing.
- The Fed and its Chairman Powell are being blamed for a lot of market reaction in which other factors are much more significant catalysts.
- Corporate profits are strong, but their rate of growth is probably also slowing.
- To me the biggest wild-card going forward is not the Fed, not trade talks, not the budget ceiling/shutdown, but the junk bond and leveraged loan credit markets. The markets have been selling-off steeply even as the Treasury market rallied. If that trend continues, it would be a bad omen for the stock market.
- Where the recent detours (mentioned above) were followed by new highs in five or six months, I’m guessing it’ll take longer this time.
- As the market works to find a low and form a bottom, keep in mind that it may be creating perhaps the best buying opportunity in several years and for several more to come.
Let’s take a quick look back at how we got here.
For years, the Fed’s Quantitative Easing policy smoothed the road ahead, but it, and the free money monetization programs of other major central banks probably also contributed to the extended valuations in stocks and bonds and other assets. Our Fed eased off the gas a couple years ago, yet the market’s upward momentum and the tailwind from continuing programs of other central banks kept the U.S. stock market on a very favorable path.
In hindsight, the market’s big 2009 – 2018 rally more or less ended on the uber exuberance run-up last January. That steep rally followed passage of the tax bill, which (among other things) greatly reduced tax rates for many corporations. Investor optimism was off-the-charts positive, suggesting (as a contrary indicator) that any significant gains in the coming months were unlikely. Right on cue, the market skidded about 9% over the next two weeks. The averages were able to gradually recover from their February pullback through the spring and early-summer. A small number of tech and internet stocks combined with some good earnings-growth projections helped the averages to approach and to just edge beyond their January peaks by late-summer.
As we reported in our “Skew of the Few” article in July, a handful of tech and internet stocks accounted for all of the market’s net gain through the first half of the year. Then, through the summer, one by one, those over-loved, over-owned stocks began breaking down. The last of the market’s leadership was suddenly veering off to the exit ramp. More and more participants (including some of the most bullish bulls) were beginning to realize that with no more strong sectors to drive the market higher, the next stretch of road ahead could be very bumpy.
In hindsight, we can find plenty of reasons for the weakness that followed. Factors including the increasing likelihood of slowing global growth, steep deterioration in credit markets, threats of a trade war, collapsing energy prices, even a skyrocketing federal deficit are all real conditions or potential problems that are now clouding the market’s view of the road ahead. This week we can add “impact of a limited Federal government shut-down” to that list.
Riding out the short-term loss was bad enough, but the market’s volatility over the past few months has made for a sickening journey. With the sell-off and the spike in volatility in October, the market went from calm to chaotic in a flash. And ever since then it seems that Chaos is still at the wheel. Whether the trigger is news-related or a break of an important technical level, when “everyone” sees the same negative development, prices tend to cascade lower as aggressive sellers scramble for any remaining bid to get out of their positions. The first whoosh down was in early-October when SPX took out its September low (SPX down 5.3% the next two days). We saw another air-pocket lower in early December when the post-G20 buying spree failed to get SPX back to 2800. SPX fell back below its 200-day moving average the next morning and went on to lose about 6% in the next day-and-a-half.
Such violent moves tend to thin out markets. “Market depth,” the relative number of shares of a stock that are available to buy or sell at nearby prices, evaporates. Market thinness tends to exacerbate the size and speed of price swings, which, in turn, tends to exacerbate market thinness. Imagine that we’re designing a computerized trading plan for just one particular stock. A key part of that plan will be its trade-sizing strategy, which in turn will depend on current and expected market depth. We want a high level of confidence that, whatever the computer determines to be the appropriate size for a new trade, it will be able to get in or out of the trade without disrupting the market. In relatively stable markets we might be able to trade 50,000 shares of the stock fairly quickly and with very little market impact. That’s good depth. Stability begets deep markets. But if a spike of volatility causes market depth to thin, the computer will reduce the size of its trades. Thinness begets more thinness. As the market stabilizes and the wide daily ranges gradually narrow, market depth should improve, and the daily ranges will gradually narrow some more.
The wave of selling into the Christmas holiday pushed the market into an extremely oversold condition. We were overdue for a rebound. Santa brought us a record point gain in the very next session. So, perhaps the pressure is off for now and the averages will attempt some sort of rebound beyond just a one or two-day bounce.
The lows on SPX on both Monday and Wednesday of this week were within about 2 points of its 200-week moving average (about 2349). SPX hasn’t so much as touched that moving average in more than seven years. Considering the wildness of market action on those days, I think stopping virtually, exactly at that moving average speaks volumes. SPX went on to rebound about 6% in just the next two days. SPX ended Thursday just below 2489. I suspect the rebound is most likely to stall in the 2525 – 2575 range over the next week or two.
Links to previously published commentaries can be found at benjaminfedwards.com/Company News/Blog/Market.
Past performance is not a guarantee of future results.