Monday, February 5, 2018

Growing Fears of a Stock Market Crash?

Fred Imbert of CNBC reports, Dow plunges nearly 800 points, was down more than 1,500 points at one point:
U.S. stocks fell sharply in volatile trading Monday, extending a steep sell-off from the previous session.

The Dow Jones industrial average shed 775 points and briefly declined more than 1,500 points. The 30-stock index also briefly traded flat earlier in the session. The Dow also broke below 25,000 and erased its 2018 gains.

"Breaking the early lows of the day means the correction could go on for longer," said Art Cashin, UBS director of floor operations at the New York Stock Exchange.

The S&P 500 pulled back 2.4 percent to break below 2,694. The broad index had traded positive earlier on Monday as the tech sector briefly rose. The S&P 500 also traded down more than 5 percent from an all-time high set last month and broke below its 50-day moving average, a key technical level.

"As soon as we broke the 50-day moving average ... we saw volatility spike," said Jeff Kilburg, CEO of KKM Financial. "It's just been downhill from there."

The Nasdaq composite declined 2 percent after rising as much as 0.5 percent. Earlier gains in Apple and Amazon helped the tech-heavy index trade off its lows.

"We're not used to getting washouts like this anymore," said Quincy Krosby, chief market strategist at Prudential Financial. "The buy-the-dip mentality that has taken over hasn't allowed for that."

"This sell-off, in the bigger scheme of things, is not that big. But it is very important in psychological terms," Krosby said.

The Dow fell 665.75 points on Friday — or 2.5 percent — notching its biggest one-day sell-off since June 2016. The S&P 500 had its worst one-day performance since Sept. 2016 and the Nasdaq posted its worst session since August 2017.

Stocks were pressured by a fast rise in interest rates last week. The benchmark 10-year yield rose to its highest levels in four years. Overnight, it reached 2.88 percent before trading around 2.75 percent.

The major indexes also capped off their worst weekly performance in two years on Friday. The Dow and S&P 500 pulled back 4.1 percent and 3.9 percent, respectively, last week. The Nasdaq lost 3.53 percent.

"What we noticed in January was that stocks and bond yields wanted to run through their year-end targets" to start off 2018, said John Augustine, chief investment officer at Huntington Private Bank. "I think both markets just need to take a breather." He also noted these pullbacks in bonds and stocks should be viewed as buying opportunities by investors.

Stocks began the new year ripping higher. The Dow and S&P 500 had their best monthly gains since March 2016 last month. The Nasdaq posted its biggest one-month gain since October 2015 in January. The major indexes had also notched record highs.

Equities benefited from strong economic data and solid corporate earnings growth at the start of the year. But increasing inflation concerns have sent interest rates higher recently, rattling Wall Street.

The White House repeatedly touted the stock market's rally last month. When asked about the market's current sell-off, they said they are "always concerned when the market loses any value, but we're also confident in the economy's fundamentals."

The CBOE Volatility index (VIX), widely considered the best gauge of fear in the market, hit 29.66.
It was a wild and crazy Monday with a flash crash reminiscent of the past where all of a sudden an unexplainable surge in selling takes hold. It all happened around 3:00 this afternoon before the dip buyers came in to dip their toes (click on image):



The Dow still ended the day down 1175 points and there are lots of nervous nellies out there worried that another 1987 crash is unfolding before our eyes.

Interestingly, all the Dow components were down big. The worst performers were Boeing (BA), Exxon Mobil (XOM), 3M (MMM), Home Depot (HD) and United Technologies (UTX), all down close to 6%, whereas the top performer was Apple (AAPL) which was down 2.5%.

The tremendous declines we've seen over the last two trading sessions have basically wiped out the strong gains stocks made in January and left the S&P 500 in the red for the year.

Fear gripped markets as witnessed from the spike in volatility (click on image):


But the good news is after suffering a dismal week last week, US long bonds (TLT) rallied sharply as investors sought refuge in liquid Treasuries (click on image):


As I explained on Friday in my comment on why US wage inflation is spooking markets, I felt US long bond yields were reaching an interim high and prices an interim low, so it's only normal we saw long bonds rally as stocks got slammed. That's the way it's suppose to work, bonds are there to diversify your portfolio and hedge against extreme downside risks of stocks.

In fact, after touching a high of 2.86%, the 10-year Treasury note rallied sharply on Monday as stocks got clobbered, with the yield falling 7 basis points to 2.79% (click on image):


This was a good thing because rising long bond yields were making investors very nervous.

Whenever you see big down moves in markets, people look for scapegoats. Goldman is blaming quants puking $190 billion globally in equities. Basically, commodity trading advisors (CTAs) that were long equities are in deep trouble if stocks keep selling off and their models stop them out of trends. There are multi-billions invested in these trend-following strategies.

Additional pressure from CTAs may further exacerbate the sell-off from risk parity funds which focus on a long-only strategy with negatively correlated assets that is sensitive to volatility spikes in the market and positive bond/equity correlation.

In English, what this means is risk-parity funds buy bonds and lever up these bond holding to get equity-like returns with lower volatility but when bonds and stocks both get slammed, these funds see material losses.

While there are billions invested in risk-parity funds, there are a lot more invested in CTAs (managed futures) type funds which is why when trends break, the fallout is violent.

So, it certainly does appear that the quants were behind this afternoon's rapid sell-off in the market:



Having said this, despite the scary price action, it's too early to declare a material break in the uptrend in stocks.

In fact, the daily chart of the S&P 500 ETF (SPY) is ugly but it tested its 100-day moving average and bounced back up (click on image):


On the weekly chart, the S&P 500 ETF (SPY) broke below its 10-week moving average and is now sitting on its 20-week moving average (click on image):


Can it go lower? Sure, it can test its 50-week moving average at $249 but this still falls under a normal pullback which is healthy for the overall market.

The problem is we are at a point in the cycle where stocks typically pull back despite good economic data. This is why even though I don't see a crash in stocks, I do recommend a more defensive stance and have outlined my thoughts in my Outlook 2018: Return to Stability.

This is why I keep recommending to pay particular attention to sectors like healthcare (XLV), utilities (XLU), consumer staples (XLP), REITs (IYR) and telecom (VOX) and avoid/underweight cyclical sectors like financials (XLF), industrials (XLI), energy (XLE) and metal & mining shares (XME).

In fact, have a look at the worst-performing ETFs on Monday from a select list I track (click on image):


And the few making gains on Monday (click on image):


Now, it's only Monday and things can change fast in these markets but Ray Dalio is right, even though these declines are just minor corrections, recent market action gives us a taste of what will happen if the Fed starts tightening a lot more aggressively than what the market expects.

That all remains to be seen. I will leave you on another somewhat positive note, high-yield bonds (HYG) were down again on Monday but only marginally and on very high volume (click on image):


I'm watching the weekly chart on high-yield bonds like a hawk to see if things are stabilizing here (click on image):


So far, there is no reason to panic but if this uptrend breaks and a new downtrend takes shape, I cannot see stocks escaping serious collateral damage.

Below, as the Dow plunges over 1,500 points, CNBC's Leslie Picker reports on the S&P 500's market capitalization. And CNBC's Bob Pisani discusses today's market activity. NYSE President Tom Farley weighs in. You can read more on why the stock market plunged today here.

Third, Ray Dalio says the market could turn quickly. Scott Colyer, Advisors Asset Management; Steve Grasso, Stuart Frankel; and CNBC's Rick Santelli discuss.

I was at the bookstore yesterday and started reading Ray's book, Principles. I honestly had no intention of buying this book but after reading the first few chapters, I was so engrossed that I decided to purchase it and read it all. There were plenty of other people sitting next to me reading his book and you can see they were into it too.

Ray talks up his Principles in interviews but it's the first few chapters of the book that I particularly enjoyed reading. To be fair, I'm far from done but highly recommend your read this book, it's excellent.

Lastly, Tony James, Blackstone chief operating officer and "Rescuing Retirement" author, gives his take on markets ahead of an extended sell-off on Wall Street. James expects stocks to correct 10 to 20 percent. He also talks about the need to devise a plan that guarantees retirement security for all Americans.

I don't know if stocks will correct another 10, 20 or 50 percent from here (doubt it) but there is no question the US has a serious retirement crisis and nobody is even talking about it. I don't like James' plan for a lot of reasons but at least he's publicly discussing this problem along with a handful of others.




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