Stocks Didn’t Like Powell’s Statement

Stocks Crater After Fed Meeting

Even though stocks entered Wednesday near the low for the year, they fell even more after the Fed’s decision and press conference. Specifically, the S&P 500 fell 1.54%, the Nasdaq fell 2.17%, and the Russell 2000 fell 2.03%.

S&P 500’s 14 day RSI fell to 31.93 which means it is on the borderline of being oversold. One more down day will likely put it below 30.

The index has done a great job of not telling you to buy stocks in the past few days. VIX was flat because it is relatively high. That explains why the CNN fear and greed index is stuck at 8. It still signals there is extreme fear. It hasn’t worked as a signal throughout this correction.

Stocks - Terrible Run Without A Recession

S&P 500 is now down 14.46% from its closing high in September; it is down 6.23% year to date. The economy is slowing, but few economic indicators forecast a recession. I think the market is falling because it is technically broken.

It has no leadership, valuations are only average, economic data is weakening, earnings growth is slowing, monetary policy is tightening, the fiscal stimulus is fading, the trade war is still on, and Chinese growth is cratering.

This explains how stocks can almost enter a bear market without a recession.

The table below shows a list of the worst months for the Russell 2000. In December, the Russell 2000 is down 12%. Out of 479 months, only 8 have been worse. The 1987 bear market crash was the worst ever for small caps as they fell 30.69%. This feels like 1987 because there isn’t a recession. However, the losses probably won’t be as bad. There are 7 trading days left in the year. The Russell 2000 was outperforming emerging market stocks by 25% earlier in the year. It’s year to date outperformance has fallen to 5%.

The table below goes through the carnage seen by individual stocks. As I have documented, small and mid cap stocks have done worse than large caps. The indexes mask the true weakness this fall. As you can see, in the Russell 1000, 63% have had negative 1 year total returns, while only 37% have had positive returns. The median stock has a 1 year return of -8.25%. The median stock is down 24.76% from its 52 week high. Only 19% of firms in this index are above their 200 day moving average.

Stocks - Facebook & FedEx Crater

Facebook stock fell 7.25% on news that the firm allowed 3rd party apps like Spotify, Netflix, and the Royal Bank Of Canada access to users’ private messages. This firm cannot go one month without a negative story coming out about it. They are usually either about politics or privacy. Instagram is the number one app on the AppStore, but Facebook is facing the wrath of regulators and users. Even though I’m bullish on Facebook in the long term, I think it will underperform if the market falls because it is a momentum name. Investors are ignoring the reasonable PE multiple because they expect that increased costs from fines, regulations, and hiring people will dig into profits.

FedEx stock was down 12.33%. In a previous article I detailed the weak guidance the firm reported. The stock did much worse than its 6% decline after hours on Tuesday. There is major economic weakness in Europe. The quote below is from FedEx’s CEO. As you can see, he thinks political issues are the main causes of economic weakness. Just because they are self-inflicted wounds doesn’t mean they will be easily reversed. I do think a trade deal will be made between America and China, but I’m not sure about the other issues.

Stock - Sector Performance

Every sector fell once again as the broad based selling continued. The best sectors were utilities and real estate as long bond yields fell and the ‘risk off’ trade dominated. The utilities regained their ability to outperform even though they are expensive. The worst 2 sectors were technology and consumer discretionary which fell 1.94% and 2.23%. This is a typical ‘risk off’ trade. It’s notable how close the performance of each sector was. 8 sectors fell between 1.05% and 1.94%. Usually cyclical stocks underperform more notably during corrections.

Stocks - Powell Knocked Down Stocks Again

My big mistake when predicting how stocks would do on Wednesday was thinking that stocks usually rally on FOMC days. They used to rally on FOMC days, but they haven’t since Powell was named chair. As you can see from the chart below, the S&P 500 has fallen 7 straight Fed days. The streak started after Powell was named chair. He is raising rates to normalize policy. He doesn’t care if stocks are volatile.

As you can see from the chart below, the stock market started to crater after Powell stated he doesn’t see the Fed changing the balance sheet policy. That’s interesting because I don’t think many economists expected the Fed to change its QE tightening program. It has been on autopilot mode since Yellen started the balance sheet unwind last year.

Stocks - Treasuries & Fed Funds Futures Market

The biggest fear about a hawkish Fed heading into the meeting was that the yield curve could invert. The curve hasn’t inverted yet, but it did flatten significantly. The 10 year yield is 2.75% and the 2 year yield is 2.65%. This 10 basis point difference is the lowest since the prior cycle. The craziest aspect of current Fed guidance is that the Fed thinks it will end 2019 with rates between 2.75% and 3%. That’s higher than the 10 year yield. It’s near the current 30 year yield which is 2.97%.

I don’t think the Fed will hike rates again this cycle. It has done enough to invert the curve. If you give the market a few more days, the 10 year yield will be less than the 2 year yield. The futures market is currently way off from the Fed’s guidance as it thinks there is a 10.3% chance of a cut by January 2020.

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1 Comment

  • Jeff Perkins

    December 25, 2018

    Awesome explanation. Very understandable; why don't we just learn to tell it like it is?? Thanks Theo Trade team. Merry Christmas to you all.