A Brief Government Shutdown
The shutdown did occur for at least a short period of time. This is another negative for the stock market which doesn’t need another catalyst to push it lower as it has been falling like a rock. Both Democrats and Republicans didn’t like the ‘deal’ that was made by the leadership of both parties.
First, let’s look at the Senate. Kentucky Senator Rand Paul is holding up the agreement in the Senate because he is worried about the large deficits I mentioned in the previous article. I’m surprised Rand and Mitch McConnell didn’t have an agreement on the deal because they’re from the same state. Specifically, Rand is against lifting the budget caps. The caps were put in place to cut $1.2 trillion in spending which was agreed upon in the sequester deal in 2013.
This new deal which raises the caps is expected to cost $320 billion in the next 2 years. As you can see from the chart below, the deficit in 2019 increases to $1.15 trillion. That’s a huge deficit for an economy that has an unemployment rate of 4.1%. It’s almost as much as the deficit in 2010 when the economy was exiting the financial crisis.
Rand Paul wants a 15 minute vote to restore the budget caps. Party leadership says this vote will take a long time because Congress members will add amendments to the bill. The issue is actually that it would force tough votes that the members who support this bill don’t want to cast.
Rand’s protest isn’t the only disagreement in Congress on this bill. In the House, minority leader, Nancy Pelosi spoke for 8 straight hours on the floor because she opposes this measure. The liberal Democrats want a solution to the DACA program which expires in March. It would be tough to get a DACA extension included in this bill because some Congress members might agree with the budget plan but disagree with the DACA extension. I thought Nancy Pelosi and other officials would be fine with an agreement with Paul Ryan to get the extension done after this bill passed, but it looks like I was wrong.
Making the chances of the budget bill passing the House even tougher is that the House Freedom Caucus opposes the bill for the same reasons as Rand Paul. The 30 member caucus is fine with funding the military, but it is against the 13% increase in spending.
Stocks Crash Reaching The Correction Threshold
The stock market crashed on Wednesday. The S&P 500 was down 3.75% and the Dow was down 4.15%. The S&P 500 and the Dow are now in a correction as they are down more than 10%. The Nasdaq and the Russell 2000 have narrowly avoided that distinction. Even though the volatility indexes are no longer in charge of the near term performance of the market, stocks still fell. The VIX was up 20.66% to $33.46, but there was little follow through selling from the complex volatility derivative ETNs. The blame for the sell off has been switched back to rising bond yields. The 10 year bond yield rose to 2.88% before falling back to 2.851%. I think the correction has been catalyzed by excessive optimism. The peak in cryptocurrencies a few weeks earlier was a great sign that peak optimism was in. The cryptocurrencies have actually been rallying recently as the total market cap bottomed at $279 billion and is now at $386 billion.
Even though most of the big tech names had great earnings reports, their stocks are down big which shows that interest rates matter more than the fundamental performance of their businesses. Since Alphabet’s earnings missed estimates, its stock is down 14.82%. While most of the big tech names have solid fundamentals, you need to know your fellow shareholders. The investors in these names are momentum traders who will sell at the first sight of a decline.
As I mentioned on Wednesday, the stock market is oversold. The CNN fear and greed index is at 8 out of 100 which means there is extreme fear in the market. I’m not sure how accurate that is because Robinhood said investors deposited 20% more money into their accounts on Monday than Friday because of the decline. If there was really fear, there would be outflows from retail accounts, not inflows. Robinhood said this is similar to their customers’ trading behavior during the August 2015 correction and the Brexit. Millennial investors have been trained to buy the dip. Until they panic, the market probably won’t hit a bottom.
The chart above shows the average bear market and average correction imposed on the current market’s performance. As you can see, the current decline is much quicker than the average corrections and bear markets. If this correction follows the average, it is almost over. If it follows the average bear market, there is still room to fall. I wouldn’t be surprised if this bear market is larger than average because of the high valuations. To be clear, I’m saying the bear market that ends this cycle will be large. I don’t think this correction will become a bear market. The current decline in a portfolio with 60% stocks and 40% bonds is only about 6.5% from the peak. The decline was 35% during the financial crisis and about 7% in the corrections in the summer of 2015 and the winter of 2016. 13% of S&P 500 stocks are below their 50 day moving average which has been consistent with near term bottoms in this bull market.
Dollar Strengthens
Besides the weakness in oil and stocks, the dollar has strengthened. This shows how every trend which existed in 2017 has reversed. The dollar index bottomed at $88.67 on February 1st and is now at $90.28. Usually the dollar rallies as a flight to safety. If the dollar increases more in the next few weeks, stocks will likely fall. The new trend has been to buy treasuries, sell stocks, buy the dollar, and sell oil.
Recent Comments