Stocks Decline Again
Surprisingly, stocks fell on Monday. The market is very oversold which usually implies a bull run is coming. I’m not saying stocks should hit a new high. But I think a 2% to 3% recovery this week is in the cards unless there’s a negative catalyst.
The S&P 500 14 day relative strength index is at 28.93. It's below 30, meaning the market is oversold. The CNN Fear and Greed index is at 11 which indicates extreme fear.
Just because the market has been oversold for a few days doesn’t mean these indicators aren’t accurate. Stay patient and buy stocks.
The S&P 500 fell 0.59%, but it is still above Thursday’s close. I expected a big gain, so a small loss is disappointing.
The Nasdaq fell 0.88% as tech stocks led the market lower again. Adobe stock fell 4.4% and Nvidia fell 4.5%. Russell 2000 was up 0.41%, vindicating my bullishness on small caps.
Stocks Decline - Traders Are Short Volatility
The VIX was down 0.05% to 21.30 even though the market fell.
That’s not completely shocking because when it’s at that level it needs more volatility to move it up than it would need if it was back in the low teens.
As you can see from the chart below, the net futures positioning of traders is short the VIX.
That’s interesting because at the end of the correction this year, traders were long the VIX. They were short the VIX at the end of 2017. Essentially, traders were wrong at the end of 2017 and the beginning of 2018. They were also wrong to be short the VIX in the summer.
However, I wouldn’t be surprised if they were correct now because I’m expecting a rebound. If traders need to be wrong, we’ll need to see them go long the VIX before stocks rally.
Stocks Decline - Tech Falls And Consumer Staples Rally
The worst sectors were technology and energy as they fell 1.64% and 0.82%. Tech stocks have outperformed for so long that this sector rotation isn’t a surprise.
The semiconductor industry is facing the end of its cycle and the big internet firms are facing tighter regulations. It’s a battle of attrition where each firm faces individual risks which add up to a declining group.
Facebook was hacked and faces regulations. Netflix faces increased competition as almost every big company is investing in video streaming. The communication services and consumer discretionary sectors fell 0.43% and 0.47%.
They house some of the big internet names. This earnings season is going to be very important for Facebook and Netflix. With the decline on Monday, the tech sector is up 1.52% from the Thursday low.
The best sectors were consumer staples and real estate. It’s possible for the market to rally without the growth names, but it’s very difficult because they have massive market caps.
It’s not great to see consumer staples leading the market because it means investors are getting defensive. In really bad recessions like 2008, even the defensive names collapse.
Stocks Decline - Buyback Stocks Not Doing Well
As you can see from the chart below, the S&P 500 buyback ETF has been cratering.
I mentioned in a previous article that firms can buy back stock even during blackouts caused by earnings season. To be clear, buybacks support stocks, but don’t guarantee they will increase.
Buybacks are a tax efficient way to return capital to shareholders. Firms that do buybacks have outperformed historically. That’s because the type of firm that has a buyback tends to be one that has a solid business model. I wouldn’t shirk buyback stocks just because they fell below the red trend-line shown below. I’m a buyer.
Stocks Decline - Stocks Only Volatile
Even though stocks have been volatile, the other markets have been fine.
As you can see from the chart on the left, the VIX and the average S&P 500 stock volatility are above the 50th percentile compared to the past 3 years and 10 years.
Copper, emerging market currencies versus the U.S. dollar, U.S. high yield credit, WTI oil, U.S. investment grade, G9 foreign exchange, and U.S. interest rate spreads all are in lower percentiles for volatility in the past 3 years and 10 years.
The chart on the right shows similar information, but in a different format. I think it’s good news stocks are alone in their volatility because the nervousness isn’t confirmed by other markets.
Stocks Decline - Speculators Are Short Treasuries
Both the 10 year yield and the 2 year yield were flat on Monday.
Latest yields are 3.16% and 2.86% which means the difference between the two is still 30 basis points. 10 year yield pulled back from it’s extreme increase in September.
The biggest question in all of markets is where it goes next. As you can see from the chart below, the net non-commercial short positions in the 10 year yield are at a record. This could signal the 10 year treasury yield will fall.
With the 2 year yield constant, it’s not a surprise to see the chances of at least one more hike in 2018 remain almost the same.
The chance of at least once hike by December is now 81.3%. The chart below shows an interesting analysis of the Fed funds rate. It counts the consecutive months where the real Fed funds rate has been negative.
It’s not the ultimate review of policy in my opinion because it uses core CPI.
Personally, I’d rather use headline PCE because that’s what the Fed follows.
However, headline September PCE hasn’t been released yet. This chart makes it look like the Fed just ended the longest period of accommodative monetary policy in history.
Austrian economists believe the Fed kept rates too low for too long which will create an even bigger bubble burst than 2008. I don’t see it that way because households have deleveraged this cycle.
I’m not worried about a big recession even though the Fed kept rates low this expansion. I need to see evidence of inefficiencies; I won’t blindly follow the ‘everything bubble’ mantra.
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