Streak Of 9 Positive Quarters Is Snapped
There were many record winning streaks snapped by the correction in February. With the weakness in March combined with the February decline, the market had its first down quarter since 2015 as the S&P 500 fell 1.22%. The Wall Street phrase “the easy money has been made” is a great description for the 2018 market. Stocks may end the year with gains, but they won’t come easy because of the increased volatility. This is mainly stemming from the weakening global economy. Earnings growth will be in the teens, but that’s mostly because of the tax cuts. The economic growth is the biggest wild card for earnings growth. A weak economy means some slight negative revisions are coming. Double digit earnings growth probably won’t be coming in 2019 with the Fed hiking rates at a quicker pace. The multiple expansion that investors had been accustomed to in the past few years has turned against them as the market has seen multiple compression. Without euphoric momentum, there’s no reason for multiples to increase near the end of an expansion.
Tech Stocks Up On A Window Dressing Rally
Stocks ended the quarter on a positive note as the S&P 500 was up 1.39% and the VIX was down 12.68% to 19.97. End of the quarter window dressing may have occurred as the FANG stocks were up big. Nvidia was up 4.6%; Facebook was up 4.4%; and Netflix was up 3.35%. Tesla was up 3.24% during the normal trading hours, but after hours it fell because the firm did a voluntary recall of 123,000 Model S cars built before April 2016 because of faulty power bolts which have seen excessive corrosion. This story is terrible news for the firm which has already been reeling due to missed production targets for the Model 3. The main cause for concern is the investment community turning on the firm. If consumers lose faith because of recalls, the firm will be crushed. The company is dealing from a position of weakness.
S&P 500 Still Above The 200 Day Moving Average
The CNN Fear and Greed index is still at 8 out of 100 which signals extreme fear. The S&P 500 is only up 2.03% from the recent low. One of the streaks the market has maintained despite the recent volatility is staying above the 200 day moving average. As you can see from the chart below, the last time the S&P 500 fell below the 200 day moving average was in 2016. Because the 200 day moving average will be increasing in the next few weeks, it will be tougher to defend than the double bottom seen on the past 2 corrections. I wouldn’t be surprised to see it broken. To be clear, I wouldn’t become a bear if the 200 day moving average is broken. It has gained importance because of the recent bounce, but I’ll still look towards the economic fundamentals to determine where I see stocks ending the year.
Cryptocurrency Collapse
One other indicator some traders are watching is the decline in cryptocurrencies. The overall market cap of these digital currencies hit a new low on Thursday. The total market cap is at $258 billion which is the lowest since November 2017. Some see the cryptocurrencies as a ‘risk on’ trade. Their decline means stocks are destined to fall if you follow this logic. Personally, I think the currencies will fall to near zero. They represented froth in January, but at some point, they become irrelevant. Stocks aren’t going to keep falling indefinitely like these digital currencies because stocks are backed by real cash flow. People will realize that they no longer work as an indicator when stocks rally at some point in the next few months while the cryptos continue to fall.
Risk Off In Bond Market
Even though the stock market rallied on Thursday, the bond market also rallied. The 10 year bond yield fell over 4 basis points to 2.74%. This means the decline from the closing high has been 22 basis points. This is exactly what I predicted. The growth and inflation band wagon got too filled. The fundamentals of the economy are modestly strong at best. The increasing yields were more about the Q4 2017 economic growth than what was happening in 2018. In this situation, I think the bond market was behind the curve. This is unlike the last yield peak in December 2013. The economic growth peaked in 2014 and then fell in 2015 and 2016. The yield started its recent upturn in the summer of 2016 which was a great signal that growth was rebounding. I’m no longer a strong bull on the long bond, but I think hitting 2.5% is more likely than 3% in the next few weeks.
The yield curve flattened again on Thursday as the 2 year yield closed at 2.27%, meaning the difference between the 10 and 2 is only 47 basis points. This should be disconcerting to investors as it becomes increasingly likely that the next cyclical downturn turns into a recession. I don’t see any huge mispricing in the market which will cause the next recession to be as bad as the financial crisis, but obviously it’s not fun to own risk assets during them.
The chart below shows the 30 year treasury along with its 2 standard deviation Bollinger bands. As you can see, whenever it hits the top end, it’s a good idea to buy 30 year treasuries. It came close to hitting that level in early 2018. This started the recent rally. In the next recession, the 30 year treasury will test the bottom end of this range.
Conclusion
Weak global economic growth has caused increased volatility in the stock market. If the Fed doesn’t pay attention to the recent weak data, it might cause the yield curve to invert this year. That would put investors on guard for a recession in late 2019. That doesn’t mean you should sell stocks because a more dovish Fed combined with some quicker growth in the 2nd half could cause a rally in stocks.
(Click on image to enlarge)
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