By Pete Biebel, Senior Vice PresidentPrint This Post
Just when it looked as though the market could trend endlessly higher with the explicit backing of the Fed, there was suddenly a spike in COVID infections. Just when the potential valuations for social networking and online shopping stocks seemed limitless, there was suddenly concern about the future. It seems more likely that the declines in the market in two of the last three weeks were not a timeout from reality; they were more a timeout from fantasyland, which, at least temporarily, is bringing prices back toward reality.
Several factors conspired to push prices higher and higher through April and May and into early-June. Initially, the promise of Fed liquidity and record fiscal support boosted optimism. Later, as the number of new COVID cases began to decline, it was easy to conclude that the worst was over. Stocks of companies immune to COVID, including many in the online shopping, online entertainment, telecommuting and pharma/biotech businesses were the obvious beneficiaries of the contagion, so their stocks steamrolled higher as their technologies enjoyed an acceleration in adoption in response to the shelter-at-home phenomenon. And, economic data was beginning to show signs of improvement. The market was looking out beyond the abyss, expecting that our economy would be back on solid footing in no time.
The market’s confidence in the ability of those factors to continue to support prices seems to be fading. The spike in the number of new COVID infections is the most obvious new reality. No one doubts that the Fed will provide another dose of its liquidity elixir if the market begins to suffer again, but there are concerns that those injections may be losing their stimulative effect. The market might benefit from additional fiscal support, but political wrangling and anxiety over the ballooning federal debt could water down or delay if not completely block those efforts. Further, it seems that a consensus is building that some of the superstar stocks in the groups mentioned above have become way too richly valued.
More recently, there have been surges of speculative excess in the market. Steep, short-term run-ups in stocks of airlines, cruise companies and even several firms on the verge of bankruptcy were signs that market valuations were getting a little nutty. And, other market sentiment gauges like measures of option trading activity, were at extreme readings.
The market was due for a timeout. The question now is whether there’s more to come. There’s still a lot of cash on the sidelines and a lot of investors who feel they got left behind by the rally. It wouldn’t take much in the way of good news to get the rally back on track.
For the week, the NASDAQ Composite Index (COMP) lost 1.9%; again, that was the smallest loss among the broad indices. COMP was able to reach a new high early last week, but, like the other broad indices, it finished at its low of the week. The S&P 500 Index (SPX) lost a little less than 3%. The net loss for the Dow Jones Industrial Average (DJIA) was about 3.3%. Both DJIA and SPX fell well short of reaching new rebound highs and both ended the week near their lows of the month and right on top of significant moving averages. DJIA, which managed to spend four glorious days above its 200-day average early in the month, has since dropped to near the 25,000 level and its 50-day average. SPX has been above its 200-day average since late-May but tested that level a couple weeks ago. Last week’s decline pushed SPX to just below its 200-day average and just 1% above its 50-day average. Caution will be warranted if SPX drops another 1.5% or more this week. In that event, SPX would have broken its 50-day moving average, made a new low for the month and would have registered the first lower low since the rally began in March.
Long Treasuries and Gold were the best gainers for the week. Only a couple other currency and commodity sectors were able to notch net gains for the week. Technology was again the best of the U.S. equity sectors with a loss of 0.5%. The next-best U.S. equity sector was Consumer Discretionary with a loss of 2.53%. At the bottom of the list were the Financials and Energy sectors. The Financials sector lost about 5.8%, partly on news the Federal Reserve ordered banks to eliminate buybacks and cap dividends in the coming quarter. The Energy sector tanked more than 7%, partly on falling prices for crude oil. Five other U.S. equity sectors had losses of between 3.8% and 4.6%.
If the coming weeks do see follow-through declines, we should be prepared for steep downdrafts. Often in the past I have described how modern market dynamics tend to generate long gradual advances and occasional steep violent declines. One significant characteristic of those declines is mechanical, forced selling. There may be a couple new reasons to expect that recent market action could increase the impact of mechanical selling. First, some, maybe most of the buyers of those superstar stocks knew that they were chasing inflated prices. As Dr. Seuss wrote, “It’s fun to have fun, but you have to know how.” Traders buying those momentum stocks likely will limit risk with stop-loss orders. Second, long-term investors who rarely use stop-loss orders, but who felt they were missing out on the rally, may have crossed their fingers and spent some of their sideline cash on new positions. Some, maybe most of them may have entered stop-loss orders below the market on those new positions. The snowballing effect of declining prices triggering stop orders could exacerbate any large declines in the coming weeks.
One potential positive development that could unfold in the coming days would be a shake-out and reversal. With SPX poised within a whisker of its 200-day moving average, the stage is set for a day that pushes the index well below that average, but that reverses and ends the day with a gain. Such an event would likely mark the end of the short-term pullback.
As mentioned above, if SPX falls more than another 1 ½% from current levels, then the decline would likely extend for another 5% or more.
The rate of increase in new COVID cases is still the top item on the catalyst list. The economic calendar is loaded with items that could signal continued economic improvement. The various employment numbers on Thursday will be the most important of those.
|Monday 6/29/2020||Pending Home Sales, May, M/M||-21.8%||+11.3%|
|Dallas Fed Manufacturing Survey, June||-49.2||-26.0|
|Tuesday 6/30/2020||S&P Case-Shiller Home Price Index, April, M/M||+0.5%||+0.5%|
|Chicago PMI, June||32.3||42.5|
|Consumer Confidence, June||86.6||90.0|
|Wednesday 7/1/2020||ADP Employment Report, June||-2,760K||+2,950K|
|PMI Manufacturing Index|
|ISM Manufacturing Index, June||43.1||49.5|
|Construction Spending, May, M/M||-2.9%||+0.9%|
|FOMC Meeting Minutes|
|Thursday 7/2/2020||Initial Jobless Claims||1,480K||1,336K|
|Non-Farm Payrolls, June||+2,509K||+3,000K|
|Unemployment Rate, June||13.3%||12.4%|
|International Trade, Trade Deficit, May||$49.4B||$53.0B|
|Factory Orders, May, M/M||-13.0%||+7.9%|
Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.