(Monday Market Close) Meet the new week. Same as the old week.
A sell-off that rolled into the weekend picked up pace Monday, taking all the major U.S. indices to 2% losses for the second-straight session and setting a new 2018 closing low for the S&P 500 Index (SPX). The storyline didn’t change much from Friday, with investors still apparently squeamish about slowing overseas economic prospects and chances of a rate hike from the Fed later this week.
Though the SPX remains a long way from entering an official bear market (down 20% from the high), it is down 13% from the year’s closing peak, and all of the FAANG stocks that helped drive momentum earlier this year are in bear territory.
If you like slasher movies, this might be the market for you, with bleeding in every sector. Even so-called “defensive” neighborhoods like utilities took a dive on Monday. There’s also a mess in the commodity pits, where crude crumbled to close below $50 a barrel for the first time in over a year. Another industrial commodity, copper, fell too.
Meanwhile, volatility spiked close to 15% as measured by the VIX, which rose back toward levels near 25 seen during the October sell-off.
What’s Going On?
One frustrating thing about the current market is its unpredictability. On a day when 10-year yields fell back toward 2.85% from last week’s highs above 2.91%, you’d think that dividend stocks like utilities might be having a banner session. But nope. They were down more than 3%, among the worst performers of the day. And even though bonds saw some buyers as risk-averse action continued to dominate, Treasuries have barely budged in the last week.
At the same time, a few of the biggest banks were flat to even up slightly Monday, and financials were one of the best-performing sectors. Normally when rates are down, people sell financials. But not so much on Monday.
This is a conundrum. The rules seem out of whack, and day-to-day that can make it very difficult to figure out what’s happening in this market. Things that would normally go down amid current fundamentals hold steady, and things that normally would go up get slammed.
Orderly March Downward
As ugly as things have gotten, the selling still seems orderly. What does that mean? It means there’s probably no sign of a real panic, which would likely be the case if we saw aggressive selling of stocks and buying of risk-off products like bonds, gold, and the VIX. This hasn’t been a true “dump” of stocks, and there hasn’t been a major spike in volatility.
What might be happening is that many investors who bought the dip the first time the market went down back in October didn’t benefit, and now they’re apparently not so willing to buy the next dip. It looks like many investors are willing to own stocks for now, but the question is whether at some point they start to throw up their hands and panic.
Also, there’s some technical stuff to consider keeping in mind. The SPX managed to close just a touch under the psychological 2600 mark last week, but then fell through technical support below that at 2570 by late Monday. That set up a test of 2530, just under the intraday low for the year of 2532 posted back in February.
By late Monday, the SPX had fallen below 2532 to set a new low for the year before swinging up slightly to end the day. Some analysts say there might be a gap in support below 2530 that extends down to near the 2400 level, which is a long way to fall. Such a drop would put the SPX within a couple of percentage points of falling into bear territory for the first time since the 2008-09 economic crisis. That means 2530 could remain the level to watch when trading starts Tuesday.
Aiming Low?
With the SPX down close to 5% for the year and facing a possible annual loss for the first time since 2015, the question might be whether the market is baking in too negative a forward outlook. Here’s why. In 2015, as the SPX fell just under 1% for the full year, earnings were also on the decline.
In what analysts then called an “earnings recession,” quarterly S&P 500 earnings fell the final three quarters of 2015, with a worse than 3% year-over-year performance in Q4. Things are a lot different now. The market is falling, but earnings have generally been impressive all year. They’ve risen more than 20% the last two quarters, and many analysts still expect mid-teens growth for Q4. Looking into 2019, the picture weakens, but it’s still not an earnings “recession” if current estimates of mid-to-high single-digit earnings growth don’t fall.
However, as an analyst on CNBC noted Monday, the SPX is behaving now as if there’s not going to be any earnings growth at all next year. The forward 12-month price-to-earnings ratio now stands at about 15, according to Factset, barely above the 10-year average (which includes the depths of the 2008-09 economic crisis), and down from 18 or higher earlier this year. So either the market is right and earnings next year have farther to fall, or the market is aiming too low, meaning you could argue the SPX is underpriced at current levels. This is a debate that’s not going to be decided anytime soon, but could make for interesting viewing as the new year rolls in.
Data and Fed Watch
From a U.S. data perspective, things continue to look pretty good, though Monday’s Empire Manufacturing number for December came in well under expectations. Some of the interest rate-sensitive sectors like cars and housing continue to come under pressure, but wages and job growth still look strong even while inflation remains manageable. The only thing is, jobs and wages are sometimes seen by economists as trailing indicators, meaning they can be the last statistics to go up in a rising economy.
There are a couple of things particularly relevant to this week that investors might want to keep in mind. First, there’s earnings from a bunch of companies, including Oracle (NYSE:ORCL), FedEx (NYSE:FDX), and Nike (NYSE:NKE). There’s also quadruple witching on Friday, marking the simultaneous expiry of stock index futures, stock index options, stock options & single stock futures. This can result in volatility as traders unwind positions.
Also, many hedge funds and traders are measured this week in terms of bonuses, so they may be unloading any positions they have that are still up for the year.
All of this pales in comparison to the Fed meeting that starts Tuesday and ends Wednesday. As the sell-off advanced Monday, chances of a hike fell to just below 70%, from 76% to start the week, according to the futures market. Those are still relatively high odds, but the Fed could be coming under pressure to delay. An op-ed today in The Wall Street Journal co-written by Kevin Warsh, a former member of the Fed’s Board of Governors, warned the Fed to take note of slowing overseas economic growth, softening credit markets, and falling commodity prices. It was titled, “Fed Tightening? Not Now.”
Figure 1: Technical Points to Ponder. The breakout to the downside has many chart watchers eyeing possible levels of technical support. Today's low in the S&P 500 Index (SPX) of 2530 eclipsed the February low of 2532, but a bit of end-of-day support kept the SPX from a settlement at a new low. Looking beyond that level to the downside, some point to the night of the 2016 election, when a head-fake break down to 2083 turned to breakout rally that seemed to be a one-way train until it derailed in February 2018. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
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