By Pete Biebel, Senior Vice President

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As 2018 ended, last week began with the narrowest range day since late-November.  Perhaps the New Year would bring some relief to the wild, wide-ranging markets that characterized the fourth quarter of last year.  On Wednesday, the first trading session of the year began with a gap-down opening, which quickly established the low of the day as the market chitty-chittied higher to a small net gain for the day.  So far, so good.  But then, the first “bang” came on explosive news from the Tech sector.  Leading stocks in that group gapped steeply lower on Thursday’s opening and dragged the averages to significant losses for the day.  The S&P Technology Sector Index lost about 5% in one day.  The S&P 500 Index (SPX) ended the day about 2 ½% lower.

Yet, just when it looked as though the market had driven off a cliff, it sprouted wings and soared on Friday.  Friday’s “bang” more than offset Thursday’s losses.  The major averages all gained 3% to 4 ½% for the day, lifting them to their highest closing levels since mid-December.  The big bang was fueled by optimism over U.S. trade talks with China, a much stronger than expected Non-Farms Payrolls number and market-calming pronouncements from the Fed’s Chairman Powell.  The major averages ended the week with net gains of 1 ½% to 2 ½%.

A couple of chitty-chitty days early in the week brought a glimmer of hope that the crazy, wide range days of December might not continue into 2019.  Then, the back-to-back bang bangs on Thursday and Friday dashed that hope.  Still, any week with a net gain is a good week considering the market’s recent circumstances.

In my ‘tween the holidays commentary, “Take the Long Way Home” (12/28/2018), I pointed to what I believe is the primary cause of the market’s recent, unusually large daily swings: High volatility begets narrow market depth which in turn begets more volatility.  This phenomenon is a very important factor in the current market environment, yet I hadn’t heard the topic addressed on any of the cable business shows.  On Friday, the website ZeroHedge published an article with the “click-bait” title “Why the Real Market Chaos Is Yet To Come: A Surprising Take From Goldman Sachs.”  The article focuses on the link between increased volatility and decreased market depth and cites one analyst who asserts that declining liquidity has been driven by increasing volatility “reinforcing a negative feedback loop between volatility and liquidity.”

I believe the current high volatility/thin market depth is a temporary condition.  Just a few ho hum weeks of reduced volatility should spawn a large improvement in market depth.  Unfortunately, the article moves to some over-the-top sensationalism when it concludes”…if the current trend of rising volatility coupled with declining delta-one volumes continues, the result will be a market in which the top-of-book depth eventually collapses to zero and where even the smallest order has the potential to unleash chaos.  That’s a very big “if.”  Despite my disagreement with its conclusion, I applaud the article for bringing some light to one of the chief factors behind the market’s recent volatility.

Another behind the scenes shift that has been cramping the market’s style is something I’ll call “The Cargo Shorts Factor.”  According to my personal fashion consultants, Jean, Lacey and Serge, cargo shorts have been out of style for the past few years.  Obviously (and I do mean “obviously”), not everyone has gotten the message.  Across a vast population, tastes and opinions change at a wide range of rates.  I suspect that cargo shorts sightings will continue for several years though at a declining frequency.  It’s much the same for fans of many of the tech and internet stocks that had been at the leading edge of the market’s gains over the past several years.  Their popularity was beyond question.  To have any hope of keeping up with the soaring market indices, you had to own shares of several such stocks.  But, the fashion-ability of those stocks peaked sometime between mid-summer and early-autumn last year.

Those over-loved darlings were suddenly out of style.  The gotta-have-it attitude that drove those stocks to too rich valuations into their peaks, has become passé.  As is the case with cargo shorts, many of those stocks are now in the “Discount” bin.  As is the case with cargo shorts, not everyone has gotten the message.  Opinions are slow to change; many investors who still own those names are hoping they’ll come back into style soon.  They may be waiting a long time (Think Nehru jackets).

Relative to their prices six months ago, many of those stocks now seem to be cheap, just like cargo shorts.  Several companies in that technology/internet category have real earnings and solid balance sheets.  Those several stocks will probably be good values when the overall market’s negative momentum subsides.  However, the majority of those former high flyers have relatively little if any earnings and questionable balance sheets; those names are likely to see their popularity continue to fade even as the market begins to recover.

Away from technology, my personal vote for “The Sector that has been Beaten Down the Most and is Likely to Rebound” goes to the Energy sector.  Even with last week’s rebound, the S&P Energy Sector Index is about 24% below its September high.  If the price of Crude Oil can level off and maybe rebound a bit, I expect it could result in good price appreciation for some of the more solid names in the sector.

My personal vote for “The Sector that has been Holding Up the Best and is Likely to Begin to Underperform” goes to the Healthcare sector.  It was the only sector that got back up to anywhere near its summer highs late in the year.  But, Healthcare tanked about 15% in the month of December and developed its most negative momentum in years.

Despite last week’s chitty-chitty bang bang, not much has changed in my assessment of market conditions.  I continue to believe that the worst of the decline is over.  I still expect that we’ll eventually see a lower low, though probably not a whole lot lower.  The current rebound is likely to stall in the SPX 2525 to 2575 range.  Market volatility is likely to continue but gradually subside in the coming weeks.

U.S. – China trade talks resume today.  Rumors of progress will encourage the market while any news of heightened hostilities will likely bang the averages lower.

Hopefully, the guy who reviews this article for publication is not a fan of cargo shorts.

Date Report Previous Consensus
Monday 1/7/2019 Factory Orders, M/M -2.1% +0.4%
ISM Non-Manufacturing Index 60.7 58.4
Tuesday 1/8/2019 International Trade – Trade Deficit $55.5B $53.9B
JOLTS Job Openings 7.079mm
   Wednesday 1/9/2019 FOMC Meeting Minutes
Thursday 1/10/2019 Initial Jobless Claim  231K       222K
Friday 1/11/2019 Consumer Price Index, M/M 0.0% -0.1%
Consumer Price Index, less Food & Energy, M/M +0.2%  +0.2%

 
Links to previously published commentaries can be found at benjaminfedwards.com/Company News/Blog/Market.