Stocks Crater - Volatile Friday
The stock market cratered Friday morning. Unlike Thursday, the market didn’t recover as the S&P 500 fell 2.33%.
Nasdaq fell 3.05% after outperforming Thursday. Russell 2000 fell 1.98%. I have forgotten to mention one reason the Russell 2000 has been falling rapidly in the past couple months is because it has a high weighting of regional banks.
Russell 2000 outperformed the S&P 500 Friday. KBW regional bank ETF only fell 0.9%.
The S&P 500’s 14 day RSI is 46.23 which isn’t an oversold reading yet. If stocks fall on Monday, this reading will quickly plummet.
Stocks Crater - Traders Show Extreme Fear
The CNN fear and greed index fell from 15 to 10 which signals extreme fear. This is a bullish signal, but I’m not bullish in the short term. S&P 500 is less than 1 point away from its November low. And it needs to fall 1.98% to hit the February low.
That means the market will be driven by the technicals in the near term. It will be very interesting if the February low is broken because it has held up in March, October, and November.
If the low is broken, many analysts will declare a bear market is coming. I’m intrigued by the possibility of the stock market selling off prior to a recession.
Usually stocks fall as the economy slows. The stock market is a leading indicator. But it would be unusual for stocks to crash in late 2018 if there’s a recession in mid-2020.
Stocks Crater - Reflexivity Coming Into Play
The theory that sentiment shifts create a self-fulfilling prophecy where the stock market and economy crater is called reflexivity.
This theory has been in play recently as the yield curve inversion, which signals a recession will occur in 17 months, has already caused volatility.
Traders are getting out ahead of the expected bear market by selling now and asking questions later.
As you can see from the chart below, Google searches for the yield curve have exploded. To be fair, the curve hasn’t inverted since 2007.
However, I have been following it all year. If traders are just discovering an inversion is bad, they might just sell stocks immediately instead of doing the research. I would never sell based on one indicator.
However, it’s possible that’s what has occurred in early December.
Stocks Crater - This Market Has No Leadership?
The S&P 500 is only down 1.52% this year. That’s far from a disaster, but I think the September high will be the record peak of this cycle.
We won’t see S&P 500 make new highs for a few years. I believe this partially because the market has no leadership. The FAAMG stocks have been weak for a few months.
Although I am bullish on Microsoft, Alphabet, and Facebook in the long term, investors are selling them all together. Apple stock fell 3.53% on Friday. Apple stock is now down year to date. I was wrong to suggest it would be fine this holiday season, but correct to be a long term bear. I didn’t know when investors would realize the business is in a secular trend lower.
Every sector was down except the utilities.
Utilities were up 0.4% because yields fell and there was a flight to safety trade. The worst two sectors were technology and consumer discretionary which fell 3.53% and 3.08%. Traders will sell the high beta names even if they are doing well.
Ultimately, every firm will falter in a recession. When you see stocks selling off too much that are doing well, buy them after the bear market has done its damage.
Stocks Crater - Treasuries Rally
Both the 10 year yield and the 2 year yield fell on Friday. The 10 year yield fell 5 basis points to 2.85% and the 2 year treasury yield fell 5 basis points to 2.71%.
That means the difference between them is 14 basis points. The curve has steepened about 3 basis points from its cycle low. Usually the curve corrects after flattening sharply. I wouldn’t be surprised if the difference between the 2 yields stays between 20 and 13 basis points for a couple months.
The issue here is that the next big flattening phase in the curve will cause an inversion.
The 2 year yield is 26 basis points off its cycle high. That is the 2nd largest decline from its high this year. When the 2 year yield peaks, it signals the Fed is halting rate hikes and a recession is coming.
Since this decline has occurred before, some will feel there isn’t anything to worry about. I think there’s cause for concern, but not because of this movement in the 2 year yield.
Stocks Crater - Fed Boxed Into A Corner
Since the 2 year yield fell 5 basis points, it’s no surprise the chance of a Fed rate hike in December fell to 71.5%. Bullard stated the Fed could hike rates in January instead of December. That would be meaningless. The goal of that change would be to hike when the volatility is over. The problem is you can’t tell the market that’s the plan or it won’t work.
It is almost impossible for the Fed to not hike rates since it has been talking about a rate hike for months. Based on the recent tone change, I expect the Fed’s dot plots to show either 1 or 2 hikes in 2019. I think the volatility will continue in 2019, making the December hike the last one.
Stocks Crater - Conclusion
The Fed meeting is 12 days away. I expect FOMC members to make dovish statements in anticipation of this meeting because they want to prevent the volatility in stocks from escalating.
If stocks rebound Monday, that might not happen. It’s not ideal for the Fed to react to stock market volatility. However, since we’ve already seen Bullard make a remark, I know the others are waiting to do the same. I don’t trust Bullard’s statement that the Fed will hike in January instead of December. But I do think the Fed will lower the number of hikes it estimates for 2019.
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