By Pete Biebel, Senior Vice President

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In my most recent commentary two weeks ago, I summarized the damage done to the market in the prior week.  Following an impressive ten-week rally off the Christmas Eve lows, it was the worst week yet this year. The averages were down on all five trading days that week.  So, the overdue pause in the rally had probably begun, right?  Nope.  Instead, the rally resumed in earnest.  The S&P 500 Index (SPX), which had stalled at the 2800 level in late-February, blew through that barrier and continued to new recovery highs.  So, the one-week stall was probably just a bear trap and the rally could continue on to the old highs, right?  Nope.  Last week started off in the right direction, and even reached slightly higher highs on SPX and the NASDAQ Composite Index (COMP), but reversals on Tuesday and Friday dropped the averages to their lows of the week at Friday’s close.

For reasons described below, the trading action over the past few weeks caused me to do something stupid: I told one of our advisors that I thought there was a good chance that we had just seen the highs of the year in the market.  That’s a very stupid thing to say for several reasons.  First, it’s probably wrong.  Second, we’re just one session off the recovery high; there hasn’t even been a lower short-term low yet.  Third, there’s nothing to gain by making such a statement.  Even if it turns out to be accurate, there’ll be no statue of me in the lobby, no big pay raise; there’s only the risk of being wrong.  And, even if I’m kinda right, even if the actual highs for the year come in the next few weeks at slightly higher levels, I’ll still be wrong.  However, the silver lining in that cloud of stupidity was that it presented a basis for a worthwhile discussion: What should I do if I know or just suspect that last week’s sneaky peak was indeed the high for the year?  And, what signs should I look for to confirm that’s the case?

The first one’s easy.  What most long-term investors should do in that theoretical situation is nothing.  Unless there’s some reason to expect a decline of 40%, 50% or worse (and I don’t believe there is), just riding out the storm is probably the best course.  They might hold off on putting cash to work for a while, but they would likely do that anyway given the inflated values in the current market.  Anyone who reduced exposure now would pay tax on the gains and would be faced with the dilemma of when to buy back in.  The most aggressive investors might enter stop-loss orders on some of their more speculative positions and/or put on some short-term hedges if/when some of the key levels listed below are violated.

Let’s say the market does decline a bit more from here; currently, the odds are pretty good that SPX will hold in or above the 2730 – 2760 range.  That’s the area of both the 50-day and the 200-day moving averages and the March low.  If that’s the worst of the damage, then higher highs are likely reachable in the coming months.  Sustained trading below that range could be the signal for aggressive investors to increase hedges.  Below that, the levels I listed two weeks ago (2675 – 2689 and 2600) would be the ones to watch.  Sustained trading below 2600 would greatly reduce the chances of getting back above last week’s high later this year.

Below are some of the contributing factors that combined to suggest that perhaps the market snuck in a peak while traders were watching the opening games in the NCAA tournament.

  • After a 12-week steep rebound rally, the market is probably overdue for at least a short-term timeout.
  • COMP and SPX made new recovery highs but ended the week with net losses and near their lows of the week.
  • While COMP and SPX had relatively small net losses for the week and still have small net gains over the past five weeks, things aren’t looking so good in smaller-cap stocks.  The even-weighted S&P Index lost about 1.2% last week, dropping it to a net loss over the past five weeks.  The Russell 2000 Index of small cap stocks (RUT) fell more than 3% last week and has lost more the 4% over the past five weeks.  Recall that deterioration in RUT late last summer (while the popular averages were making new highs) was one of the early signs that trouble was brewing.
  • Despite the appetizing stock market gains year-to-date, government bond yields are indicating a sudden flight to safety.  Prices on Ten-Year Treasury Notes were bid up steeply, dropping their yield to its lowest level in 14 months.  A Bloomberg index of global sovereign yields fell to its lowest level in 11 months.
  • Stocks in the Financials sector had a particularly bad week.  The flattening yield curve contributed to sizeable losses in banks large and small.  The S&P Financials Index was the poorest performing U.S. sector, down nearly 5% for the week.  The KBW Bank Index fell more than 8% for the week.  The NASDAQ Community Bank Index lost more than 9% last week.  The overall market is unlikely to perform well if weakness in Financials persists.
  • According to the website ZeroHedge, since the end of World War Two there have been 19 uninterrupted declines of at least 15% like the late-2018 sell-off.  In every case, “the low resulting from the waterfall decline was retested, and in 15 of 19 cases a new lower low was made.”[i]
  • Last summer’s highs were reached at the autumnal equinox.  December’s lows were very near the winter solstice.  Last week marked the spring equinox.  That is of little technical significance but is still an eerie coincidence.

If the averages can recover at all this week, then all of the above is just a rhetorical exercise. No harm done but forewarned is forearmed.

This week brings a long list of economic reports and the beginning of the media frenzy that will likely be detonated by the release of the Mueller report.  The economic data will be closely watched for signs of a slowing economy.  Any details of Special Counsel Mueller’s report that might leak out during the week aren’t expected to have much market impact.  Traders will likely be more focused on their NCAA basketball brackets than on the Mueller findings.

 

Date Report Previous Consensus
Monday 3/25/2019 Chicago Fed National Activity Index  -0.43  +0.10
Dallas Fed Manufacturing Survey 13.1  10.0
Tuesday 3/26/2019 Housing Starts, SAAR 1.230mm  1.201mm
S&P Case-Shiller Home Price Index, M/M +0.2% +0.3%
FHFA House Price Index, M/M +0.3% +0.3%
Consumer Confidence 131.4 132.5
Richmond Fed Manufacturing Index 10 11
Wednesday 3/27/2019 International Trade, Trade Deficit $59.8B  $57.4B
State Street Investor Confidence Index 70.9
Thursday 3/28/2019 Initial Unemployment Claims 221K 225K
GDP, Q/Q, SAAR +2.6%  +2.2%
Pending Home Sales Index, M/M +4.6% -1.0%
Kansas City Fed Manufacturing Index 1
Friday 3/29/2019 Personal Income and Outlays, Income, M/M -0.1% +0.3%
Personal Income and Outlays, Spending, M/M  +0.3%
Chicago PMI 64.7  60.3
New Home Sales, SAAR 607K  616K
Consumer Sentiment 97.8  97.8

 

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

[i] Bank Bloodbath Brings Down “Bull Market” as Yield Curve Crashes published on ZeroHedge.com at 4:01 EDT on 3/22/2019