By Pete Biebel, Senior Vice President
The stock market was in the peak of health through the first three weeks of the year. In fact, it had chalked up a 15+% gain from early-October to its high just after mid-January. But it was beginning to look a little green in the gills the following week when news of the widening coronavirus outbreak infected the averages. Its condition worsened considerably last week, from looking slightly peaked to lapsing into critical condition, culminating with a convulsive 600-point loss in the Dow Jones Industrial Average (DJIA) on Friday. The headlines made it sound like the market was in need of hospice care: “The NASDAQ Composite (COMP) and the S&P 500 Index (SPX) had their worst start of the year since 2016.” “DJIA worst day since 8/23/2019.” “SPX worst day since 10/2/19 and worst week since August 2019.” Fortunately, the reports of the market’s demise were likely greatly exaggerated.
Clearly, much of the market’s weakness last week was a symptom of the continuing spread of the coronavirus. It began with a big gap-down opening on Monday that saw the averages then stabilize and chop through the next few days with a small net gain. The market was hoping that the contagion, in the end, would be no big deal. But the patient’s vital signs continued to weaken, leading to Friday’s Code-Blue rush to the exits. On Friday alone the major averages all lost between 1 ½% and 2%. For the week, DJIA had a net loss of about 2 ½%. COMP lost only 1 ¾% and SPX was right in the middle with a loss for the week of a little over 2%.
It’s important to keep a few things in mind when assessing the extent of last week’s damage. Most important is that the averages had all climbed into steeply overbought conditions in the past several weeks. Less than two weeks ago, the headlines were celebrating the market’s very bullish beginning of the New Year. As I have written in recent weeks, stocks were unlikely to see substantial additional gains over the short-term; they were way overdue for a timeout. And, as I wrote last week, “It’s also a condition in which a little bad news can go a long way.”
Another of my caveats from last week was, “Any further decline beyond the losses of late last week will break the short-term uptrend off the October low.” That break occurred at the very beginning of last week when the averages all gapped down on Monday’s opening. SPX found support that day near the 3250 level. Much of the Monday losses were recovered when prices rebounded on Tuesday and Wednesday. Another gap-down opening on Thursday saw SPX once again testing that 3250 level. When selling pressure on Friday morning pushed SPX below that level, everybody knew the patient had taken a turn for the worse.
Much of the subsequent loss on Friday was simple mechanical selling that triggered when the averages broke below critical levels. The break of support confirmed the market’s failing health, and nobody was willing to bet on a quick recovery. It became an afternoon of all sellers and very few buyers. It was very typical of the occasional downdraft days the market has experienced over the past several years. In recent years, the day-to-day market action has come to be dominated by systematic traders, high-frequency traders and passive index funds. All of those systems are programmed continue to buy stocks as long as the trend is up, irrespective of “Value.” But, when the trend turns down, they all become simultaneous sellers, irrespective of value. The end result is that gradual uptrends can persist for a long, long time, but the occasional reversals can be very steep and very fast.
Friday’s steep, fast decline suggests that we may be in the early stages of such a phase. But the odds are that the damage will be contained. The strong upward momentum at the recent high increases the probability that the current markdown malady won’t turn into a contagion. In my first few articles in the New Year, I guessed that SPX would spend most of the first quarter of the year between 3100 and 3300. Friday’s sell-off left the index near the middle of that range. So, so far, it’s been a typical, if slightly overdramatic pullback. Another 3% to 4% loss is certainly possible, but any loss approaching that magnitude should present an attractive buying opportunity. While Friday’s selloff was bad, it wasn’t THAT bad. And, while additional losses seem likely, they’re probably not going to be substantial losses.
Again, the flipside of investors rushing out of stocks last week was their rush into “flight to safety” assets. Again, Treasury Notes and gold, among others, extended their recent rallies. The yield on the benchmark Ten-Year, which was near 1.82% two weeks ago, and was forced down to 1.688% in the prior week, sank to just 1.52% last week. That’s within about ten basis points of its multi-year low yield set last fall. Gold gave back part of last week’s gain early in the week but gained about 2% late in the week as stocks sold off. Gold ended the week just below $1600 per ounce, its highest closing price in nearly seven years.
Thanks to the continuing rally in Treasuries, most interest rate sensitive sectors ended the week with small net gains. Almost everything else was in the red. Most international equity markets had losses even larger than those of U.S. stocks. Several emerging market equity indices had losses of 3% to 6% for the week. And, that was with markets in China closed for the Lunar New Year holiday.
With news from the Iowa caucus results, the State of the Union address, the approaching closure of the impeachment hearing and continuing developments in the coronavirus outbreak, the significance of non-market news this week could be “yuuuge.” After all the positive news was priced into the market through December and early-January, it looks like earnings reports may be our last hope for any new good news.
|Monday 2/3/2020||ISM Manufacturing Index||47.2||48.5|
|Construction Spending, M/M||+0.6%||+0.5%|
|Motor Vehicle Sales, SAAR||16.7mm||16.8mm|
|Tuesday 2/4/2020||Factory Orders, M/M||-0.7%||+1.2%|
|Durable Goods Orders, M/M||+2.4%|
|Durable Goods Orders, ex-Transportation, M/M||-0.1%|
|Wednesday 2/5/2020||ADP Employment Report||+202K||+158K|
|Trade Balance, Trade Deficit||$43.1B||$47.8B|
|ISM Non-Manufacturing Index||54.9||55.1|
|Thursday 2/6/2020||Non-Farm Productivity, Q/Q, SAAR||-0.2%||+1.5%|
|Initial Jobless Claims||216K||215K|
|Friday 2/7/2020||Non-Farm Payrolls||+145K||+160K|
Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.