S&P 500 Matches February Closing Low With Monday Decline

Big Sell-off On Monday

There was a sharp decline on Monday in which the S&P 500 fell 2.23% and the Nasdaq fell 2.74%. The VIX was up 18.28% to 23.62. The S&P 500 fell to 2,554 in the afternoon before rallying a bit near the end of the trading session. It closed about 1 point above the February low. The market is precariously close to breaking out of its recent range to the downside. If it does, I only expect a few percentage points of downside since I’m sticking with my original prediction to start the year which was a 10%-15% correction.

This decline broke a 643 day streak where the S&P 500 was above the 200 day moving average. This was the 2nd longest streak since at least 2000. Some think breaking this streak was bad news, but I disagree. The plethora of record positive streaks in January were negative signals for stocks as they indicated euphoria. January 2018 will mark a pivotal point in market history because it will be known as peak optimism.

This doesn’t mean stocks are destined for failure. It means the fundamentals will become more important. Unless you think a recession is coming, it makes sense to buy into corrections. This strategy has burned some in the near term because they have been used to 3% declines. An average year has one 13% decline. I think it’s great that the stock market is getting rid of the euphoria without a recession. If a recession was to start in 2018 the total declines could get ugly as the euphoria became panic.

Tech & Momentum Continue Falling On Monday

The tech and momentum stocks have led the market down in the past few days. As you can see from the chart below, the momentum factor fell about 4% on Monday. Intel stock led the charge to the downside because Apple was reported to be ditching Intel chips in its Macs by 2020. Intel isn’t a momentum name, but it did hurt the tech sector. Netflix is one of the few momentum names in the FAANG group without bad news coming out about it, yet its stock was down 5.1% on Monday and it’s down 15.54% from March 9th. Nvidia stock was down 4.55% because analysts lowered their price targets because the cryptocurrency crash will mean fewer chip sales.

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As you can see, the decline in momentum and tech stocks is a combination of a bunch of negative news events hurting individual names along with a sector rotation centered around taking risk off the table. Consumer discretionary and tech were the worst sectors as they fell 2.83% and 2.48% respectively. Netflix and Amazon are in the consumer discretionary sector which explains the downside. The consumer staples sector had a terrible day as it was down 2.45%. You would expect consumer staples to be part of the flight to safety trade, but the sector was pulled down my Wal-Mart stock which fell 3.83% because of the rumors it will buy Humana, a health insurance company. Wal-Mart stock is on a terrible run as it is down about 22% since the all-time high set on January 29th.

Technical Analysis

The chart below shows the number of new highs and new lows in the S&P 500. Amazingly, near the peak of the market 2,083 stocks hit 52 week highs. That’s about 40% of the market. Such euphoria was palpable after the strong 2017. It was unsustainable. There were headlines which read that stocks could never fall again. The current number of new lows pales in comparisons to the new highs in January. I don’t think the negativity at the capitulation point of this correction will get as high as the positivity got in January because we’re not entering a recession. The CNN Fear and Greed Index is at 7 out of 100, but I wouldn’t say we’re close to how bad negativity can get. On the bright side the Shiller PE has fallen to 31.07. When the 2008 earnings are taken out, it will look closer to normal, quelling some of the fears about valuation.

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Bonds Remain Steady During The Latest Equity Decline

Unlike in previous sell offs in the past few days, the long bond didn’t rally as stocks fell. The TLT started down and closed up 0.2%. The chart below shows how the hedge funds have moved out of their extremely short position in the TLT. I would like to see more short covering before I’d expect the TLT to fall and rates to rise again. The 10 year bond yield is currently at 2.74% and the 2 year yield is at 2.25% making the difference 48 basis points. On the one hand, a flat curve is bad, but on the other hand, the Fed may react to it in the next 6 months by slowing its rate hikes. I would argue that right now the Fed is correct to not be concerned. Some investors don’t realize how far 48 basis points is from an inversion. My time frame for an inversion in the second half of 2018 or the first half of 2019 remains. I’m interested to see how the Fed reacts when the difference is below 25 basis points.

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Breadth Still Not Weak

The chart below shows the breadth in global equities. It looks at the percentage of markets that are above their 200 day moving average. Even though the U.S. economy hasn’t been in a recession since 2009, equity breadth was very weak in 2011 because of Europe and in 2015 because of emerging markets. Global stocks have fallen with American stocks, but the breadth doesn’t even signal this is an average correction yet. I’d like to see more downside before I am sure global markets are near a bottom. To be clear, this doesn’t mean a massive amount of downside. Some markets need to fall a couple percentage points to be below their 200 day moving average like America. To be clear, falling below the 200 day moving average is not the end of the bull market in American stocks. This happens often in bull markets; it just hadn’t happened in a while.

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