By Pete Biebel, Senior Vice PresidentPrint This Post
The stock market just had its best week since 1974. Over the past several weeks, investors have cycled through a series of high emotions driven by the rapid and dramatic shifts in market valuations: Fear, panic, relief and now confusion. Was the huge rebound over the last few weeks the beginning of a new bull market? Or, was that rally just a brief but spectacular rebound in a continuing bear market? Is the rally an opportunity to get more defensive or, is it a signal that the coast is clear to be more aggressive? Was the Fed’s mega dose of liquidity on Thursday the cure for the market’s ills, or just a placebo?
Last week was probably either the confirmation of the new bull market or the last gasp of the rebound rally. In other words, there’s a very high probability that we’re at a coin flip moment. Consensus opinion seems to be about a fifty-fifty split between “new bull market” and “lower lows still to come.” Months from now, looking back at this Easter weekend, we’ll probably see that it was at or very near the inflection point for the market. The market’s gains last week have brought us to the point where the right thing to do now is to either buy everything or sell everything. I suspect that exactly nobody is going to do either one. Nevertheless, depending on your bias on principal protection versus growth potential, some action toward one or the other extreme might be appropriate now.
The event that has brought us to this paradox is that, so far, the rebound has been perfect. I’ve described over the past several weeks how rebounds in continuing bear markets are usually very impressive and usually extend to a point which convinces many that the lows have been seen. It’s been a just-what-the-doctor-ordered rejuvenation of a market that appeared to be in critical condition a few short weeks ago. That March low came on a wave of panic selling, which precipitated the expected “rally through the vacuum” rebound. That rally stalled for a week or so near the first rebound target level (SPX 2640 – 2650). Then, SPX blew through that level late-Monday and made a three-day bee-line to the next target level near 2800.
The past two years have experienced a similar coin-flip, paradox moment on two occasions. In late-2017, the averages had been trending steadily higher, then rallied steeply in January 2018, setting new highs almost every day. Then the averages plunged about 12% in just two weeks. Two weeks later, the index had recovered about 50% of the loss, but instead of it being a an inflection point moment, it merely signaled the end of the volatility. As the market rebounded, I continued to believe that a lower low was still likely, but it never came. The averages got close to their February lows in early-April, but in the end, the market just see-sawed in a narrowing band for the next five months.
The sell-off into the Christmas Eve low in 2018 is the most recent parallel. The market fell about 16% that December, bringing its loss from the October high to about 20%. As the market rebounded in January, I felt that the extremely negative momentum on that recent decline meant that a lower low was likely. A week into the New Year, the averages stalled after recovering about 50% of the December decline. By mid-January, the averages had recovered about 50% of the overall slide. In retrospect, that was the make it or break it moment. The market waffled for a week or so, but when it made a higher recovery high in late-January, it was a signal that it was buyin’ time again. The market trended higher for the rest of the year.
The point is that, over the last few years, I’m zero for two on guessing correctly whether a lower low would follow a recent steep decline. So, rather than burden you with another worthless guess, I’ll provide some points to consider and some alternatives for taking action in the near future.
Reasons to be bullish:
- The curve has flattened. When the contagion sell-off began, the consensus expectation was that, by the time the rate of infection in the U.S. leveled-off, the market low would have already been seen.
- The Fed’s liquidity injections have restored order in the credit markets.
- The Fed seems to have every intention to spend whatever it takes prevent market calamity.
- The “money is no object” fiscal response will prevent the recession from deepening.
- Earnings Season is right around the corner.
- We may all be going back to work sooner than expected.
Suppose I’m convinced that the bottom is probably, maybe in. What alternative approaches short of diving in head-first might I consider now?
- Sit tight for now but set levels at which you will take action. For example, I might plan to buy if SPX sees sustained trading above 2815; and be prepared to sell if/when SPX falls back below 2650.
- Buy partial positions now with a plan to add on strength and with an established “stop-loss” level on each of the new positions.
- Fine-tune your shopping list now with the plan to buy on dips going forward. Don’t chase the current spike up, but instead wait for opportunities on pullbacks, but only if those pullbacks are well controlled (i.e. no air pocket declines).
- Dollar cost average into index or sector funds. Maybe 20% investments at two-week intervals over the next eight weeks.
Reasons to be cautious:
- The weakest groups were the big winners last week.
- Friday’s gain should have been much larger if this was a new bull market. Instead, the averages stalled at their 50% retracement, then faded and closed well below those levels.
- Earnings Season is right around the corner.
- So far, the rebound has been exactly as expected and no more.
- Even if many of us go back to work in the next month or two, it’ll likely be a much longer time before we’re all going to restaurants and movies and theme parks let alone flying on airplanes or staying in hotels.
- Buy the rumor, sell the news. The market got the expected reaction to the curve flattening news, and the expected reaction is usually wrong.
- The “free money” policies may have reached the tipping point. No one knows what impact these current extreme actions might have on inflation, the U.S. Dollar and the level of interest rates later this year. The market’s addiction to those Fed injections has intensified the dependency over the years. If we reach the point the Fed can no longer help, things could get ugly.
Suppose I want to be more defensive, what alternative approaches might I consider now?
- Sell some of those losers that you wish you had sold a month ago. Even if you change your mind in a few weeks, you can then rotate the cash raised into stronger names.
- Establish hedges for existing positions. Several alternatives are available for reducing portfolio risk; talk to your advisor.
- Establish stop-loss levels for some of your current holdings. Determine at what price levels below current market you will pull the plug on some of your exiting positions.
- Consider directing some sideline cash into non-correlated assets like gold or a long/short commodity fund.
Some settling back this week, after last week’s gain, wouldn’t be unusual and wouldn’t immediately set off any alarms. SPX could pull back 3% to 4% into the mid-2600s without breaking any significant technical levels.
This first week of the new Earnings Season will be dominated by reports from big banks. The first-quarter results will reflect performance through two healthy months and only one month that was impacted by the Covid-19 contagion. Throughout the first weeks of this season, analysts will be focused on the reporting firms’ guidance for the coming quarters. The actual first-quarter results will provide a hint of the damage to date, but the outlook for the coming months is the information that has the greatest potential to move stocks.
This week’s long list of economic reports is the first that will begin to show the initial economic impact of the contagion. We could see big opening gaps either up or down if the actual data varies significantly from the consensus. Wednesday’s Retail Sales data and the Initial Claims number on Thursday seem to be the most likely to spark a reaction.
|Tuesday 4/14/2020||Import Price Index, M/M||-0.5%||-3.2%|
|Wednesday 4/15/2020||Retail Sales, M/M||-0.5%||-8.0%|
|Retail Sales, ex Autos & Gas, M/M||-0.2%||-5.0%|
|Empire State Manufacturing Index, April||-21.5||-35.0|
|Industrial Production, M/M||+0.6%||-4.2%|
|Manufacturing Production, M/M||+0.1%||-4.1%|
|Fed Beige Book|
|Thursday 4/16/2020||Housing Starts, M/M||-1.5%||-18.3%|
|Philadelphia Fed Survey, April||-12.7||-30.0|
|Initial Jobless Claims||6,606K||5,000K|
|Friday 4/10/2020||Leading Indicators, M/M||+0.1%||-0.7%|
Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.