One thing that continues to amaze our research team is the total scale and scope of the capital shift that is taking place across the globe. For almost 5 years, foreign investors have been piling into the U.S. stock market chasing the stronger U.S. dollar and continued advancement of U.S. share prices. It is almost like there is no other place on the planet that will allow investors to pool capital into such a variety of strong assets while protecting against foreign capital risks. Yet one big question remains – when will a price reversion event hit the U.S. stock market?
So many researchers, even our team, feels they have found the keys to unlocking when the price reversion event will take place. Time-honored technical analysis techniques have set up very clear triggers that were negated by higher prices and continued upside trending. What is certain at this point is that the capital shift is going to continue until it stops – at some point in the future.
Our team decided to take a look at the FANG index and the individual symbols that make up that sector to see where the real strength and weakness exist. Our goal was to attempt to understand how and when a potential price reversion will happen and how such an event may be correlated to the global contraction related to the Coronavirus. Could the virus be the catalyst that sets off a breakdown in the technology sector?
There are three components we want to focus on. First, the very real possibility that we are “rallying to a peak” at some point in the near future. Second, the Custom Volatility Index highlighting continued overbought price action and the very real potential for a breakdown in price from these inflated levels. Lastly, the FANG index itself suggesting we are very near to upper price boundaries after capital has poured back into the U.S. markets in early 2020.
These three components suggest a market that is full of overly enthusiastic optimism and capital that has poured into the U.S. stock market chasing gains that were clearly expected as 2019 came to a close. Yet in early 2020, a new risk suddenly became known, the Coronavirus, and this risk has already begun to devastate China's economy and economic activity. What happens if this sudden collapse in economic activity spreads over the next 30+ days and how will it change future expectations for the U.S. stock market?
This weekly custom Technology Index chart highlights what we clearly believe is the “rally to the peak” type of price action related to the continued capital shift taking place in global markets. The breakout to the upside in November 2019 prompted a concentrated pooling of capital into U.S. markets. After the end of the year, when institutional investors started engaging in the markets again, it was rumored that more than multiple-billions reentered the markets in early January 2020. It is obvious when you look at this chart.
By the second week of the new year, capital continued to pour into the technology sector – pushing it higher by nearly 15% in less than 45 days. That is an amazing rally to start off 2020 and could possibly be the “rally-to-the-peak” process we've been hinting about.
This Custom Volatility Index is something we use to determine how overbought or oversold the U.S. stock market is in relation to historical VIX-weighted price ranges. When this index is above the GREEN middle range, the U.S. stock market is reaching into extremely bullish trending and overbought territory. When the index is below the GREEN middle range, the U.S. stock market is reaching extreme bearish trending and oversold territory. The GREEN middle range is a neutral zone for trading.
Obviously, as VIX spikes and price levels collapse, we can see this Volatility Index falling to levels below 6.0. As price trends higher with moderately low VIX levels, we continue to see the index hover above 12-14. The downside rotation in the U.S. stock market (the -600 pt. Dow day) pushed this Volatility Index from near 22 to 14 – a big reversion event on this chart. Now, the current level is back above 18 and pushing higher – the rally to the peak is setting up.
Lastly, this weekly FANG chart highlights the concentration of capital that has pushed the technology sector, and particularly the FANG stocks, much higher in 2020. The reality of the situation is that until forward expectations, guidance or global economic functions change, this rally will likely continue for some time. Our concern is that global market expectations could change very quickly in relative terms because of global economic functions and contractions related to the Coronavirus.
We recently wrote an article suggesting that the entire Belt Road sector could become a risk factor if China is pushed into a deep economic crisis. China's banking sector recently underwent a stress test where China's economy dipped below expected GDP levels. Nearly 15% of China's banks will become insolvent if GDP drops below 5.5%. Nearly 50% of China's banks will become insolvent if GDP drops below 4.5%. What happens if China's GDP drops to 0.5% for a 4-to-6-month span and the Chinese economy sputters in recovery after this Coronavirus event settles?
What happens to the Belt Road Initiative and the projects/relationships China has with those nations if, all a sudden, China enters a credit crisis in excess of $5 to $6 trillion U.S. dollars. Bloomberg recently reported that China Home Sales plunged 90% in the first week of February. You don't have to be a genius to understand the risks associated with that type of fall in a key economic growth component.
If our research team is correct, this rally to the peak will continue in the U.S. for as long as risk factors stay mildly calm for the U.S. Once risk levels elevate to a point where U.S. investors and the economy become threatened, then traders will likely begin to bail out of overvalued sectors, like technology, and into safe-haven investments. It is critical that traders be prepared for this move because when it happens, it may happen quickly and violently.