Just last week, we were asking the opposite question, as
traders were believing that the market had immunity to the risks from the “coronavirus.”
This was a point we discussed in Monday’s technical market update.
“As noted last week: ‘With the
market now trading 12% above its 200-dma, and well into 3-standard
deviations of the mean, a correction is coming.’ But
the belief is currently ‘more stimulus’ will offset the ‘virus.’
probably a wrong guess.
Extensions to this degree rarely
last long without a correction. Maintain
exposures, but tighten up stop-losses.”
That correction came hard, and fast on Thursday and Friday.
For the week, the market declined, but it was the “5-Horseman
Of The Rally”(Apple, Microsoft,
Google, Facebook, Amazon) which led the way lower. This is the first
time we have seen a real rotation out of the “momentum
chase” into fixed income and was a point we discussed in Thursday’s RIAPRO
Intermarket Analysis Report. To
“Stocks and bonds play an
interesting ‘risk on/risk off’ relationship over time. As shown above
while stocks are extremely outperforming bonds currently, the
relationship is now suppressed to levels where a reversion would be
suggests that we will likely see a a correction in equity prices, and a
rise in bond prices (yields lower), in the near future.”
Currently, this is just a correction within the ongoing bullish trend,
are things occurring that do not rule out the possibility of a larger
correction in the short-term.
Carl Swenlin from Decision Point (h/t G.
O’Brien) came to a similar conclusion.
“Yesterday (Thursday) SPY penetrated
the bottom of a short-term rising wedge, but couldn’t make it stick.
Today was a different story, but the support line drawn across the
January top impeded excessive downward progress. The VIX didn’t quite
reach the bottom Bollinger Band, but it is possible that we will see
continued weak price action similar to the short January decline if the
VIX breaks through the band. Being so close to the band, the VIX is also
it is also possible that we’ll see a bounce.”
“The intermediate-term market trend
is UP and the condition is SOMEWHAT OVERBOUGHT. The
negative divergences spell trouble, and all four indicators are below
their signal line and falling.
The market has been so resilient
that it is hard to think that anything more than a minor pullback is
possible. A critical breakdown below the January top hasn’t happened
yet, but that could be the first move on Monday. Indicators
in the short- and intermediate-term are falling, and negative
divergences are abundant, so I think that next week will be negative.
That may just be the beginning.”
We agree with that assessment. Remember,
it never just starts raining; clouds gather, skies darken, wind speeds pick
up, and barometric pressures decline. When you have a consensus of the
evidence, you typically carry an umbrella.
Evidence is clearly mounting, and one of the bigger concerns to the market,
and particularly to the commodity space, is the surge in the U.S. dollar.
This past Monday,
“As noted previously, the
dollar has rallied back to that all important previous
resistance line. IF
the dollar can break back above that level, and hold, then
commodities, and oil, will likely struggle.”
That is exactly what
happened over the last two weeks and the dollar has strengthened
that rally as concerns over the ‘coronavirus’ persist. With the
dollar testing previous highs, a break above that resistance
could result in a sharp move higher for the dollar.
The rising dollar is not
bullish for Oil, commodities or international exposures. The
‘sell’ signal has began to reverse. Pay attention.”
This surge in the dollar is also responsible for the sharp drop in bond
yields as money is flooding into USD denominated assets due to the coming
global impact from the coronavirus.
This is a
substantial risk to the markets over the rest of this year which has not
been factored into asset prices as of yet.
Furthermore, the main driver behind stock prices since last October has been
the flood of liquidity from the Federal Reserve. However, that push of
liquidity has quietly gone subsided over the last few weeks.
This was well telegraphed by the Fed previously but was reasserted this past
week as the Fed noted it was in no rush to cut rates and would continue
reducing “repo operations,” both
into, and following, April.
Given the “bull thesis” has been “liquidity
trumps all other risks,” with the Fed funds rate at 1.5% currently, and
liquidity flows being reduced, “risks” now
have a stronger hand. When you combine reduced liquidity with a surging U.S.
Dollar, and collapsing yields, investors should reassess their positioning
“The EURUSD jumped sharply (after
falling steadily YTD) and the spooz took another leg down. Could there
have been a European institutional account positioned in US stocks which
suddenly decided, like
the Jeremy Irons character in the Margin Call movie, that they didn’t
“hear the music” anymore, and decide to sell? If they had owned
US stocks without hedging their FX risk the temptation to hit the SELL
button given the recent huge rallies in both US stocks and the US Dollar
would have been huge! I
think the S&P 500 can continue lower.”
Review & Update
We have been concerned about the potential for a correction for the last
three weeks. Given that we previously took profits near the market peak in
January, there was not a tremendous amount of work we needed to do on the
equity side of the ledger.
However, this past Monday we did extend the duration of our bond portfolio a
bit, and changed some of the underlying mixes of bonds, to prepare for a
correction. With the sharp yield spike over the last couple of days, those
positioning changes worked well to reduce volatility.
We are using this correction to rebalance some of our equity risks as well.
The bull market is still intact, so it is not time to be bearish in terms of
positioning, just yet. However, we are maintaining our hedges for now until
we get a better understanding of where the markets are headed next.
Currently, there are several levels of support short-term. The market
bounced off initial support at the 38.2% retracement level at the end of the
day on Friday. However, we suspect we will likely see more follow-through
next week, particularly if the dollar continues to strengthen. Downside
risk currently resides at 3250, but a break below that level will suggest a
much bigger correction is underway.
Longer-term, given the unrecognized impact of the virus on the economy, we
expect a bigger decline down the road. As Doug Kass noted on Thursday:
warranted. What we have all learned of the virus is that it is
easily transmitted. It is asymptomatic, well established and it is
spreading. As I have also noted its spreading has been under reported
and, unlike other market headwinds, the
liquidity provided by central bankers will have NO impact on the damage
inflicted by the virus’ contagion.
Among other issues, global travel
will be decimated and this will have unusual ‘knock on’ effects.
Tourists, especially Chinese ones, spend lots of money. This
will be a GLOBAL problem as China was to be a source of big growth for
this sector. Retailers of EVERYTHING are going to miss budgets and
economies like Japan and South Korea are going to be devastated by the
In Japan, this will come after a
massive (and ill timed) tax increase. Tech will play the role of major
(not minor) collateral damage as long held supply chains are
investors, focused on price action, have little idea what could hit
We are keenly aware of the risk, and while we are not “selling
heavily and moving to cash” currently, it doesn’t mean we won’t.
We are paying attention to what the market is saying, and following