Stock Market Reversal - Big Reversal On Tuesday

There was a major Stock Market Reversal on Tuesday. The stock market started the week oversold. This explains why the S&P 500 opened the trading session positive on Tuesday. 

CNN fear and greed index started the day at 27 which is fear. However, the market fell throughout the day because of bad data and trade war fears. Fundamentals matter more than the technicals in this case. The market was overbought for most of the first 4 months of the year, yet it kept increasing. 

Now the fundamentals have gotten worse, so stocks must fall even though they are oversold. I think a total drop of 10% is in order. I have been saying this ever since the weak Markit PMI and durable goods orders came out.

S&P 500 ended the day down 0.84%. From its peak at 9:50 AM, the S&P 500 fell 1.36%. That explains why the CNN fear and greed index fell to 25 which is extreme fear. The market can easily have a big short term rally because it is oversold. 

However, once that’s over, stocks will fall again because the current recession scare is arguably more valid than the one late last year. Last year’s scare was preemptive. Also, keep in mind that if the stock market fell 20% again, I’d likely be bullish. 

A total of 10% correction only means the market falls about 5% further. The market is very close to its first 5% correction of the year as it is down 4.87% since April 30th. That type of decline is normal. The market probably should fall further because there is an increased possibility that this cycle is over.

Sector By Sector Action

Nasdaq fell 0.39% and Russell 2000 fell 0.67%. VIX spiked 10.41% to 17.5. Personally, I think the VIX is relatively low. That’s probably because this hasn’t been a violent correction. There hasn’t been enough volatility to scare the bulls. Bulls should be scared by the economic data. If they haven’t been following it, they are in trouble.

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Utilities finally cratered on Tuesday as the sector was down 1.61%. 

As you can see from the chart above, these stocks have historically high PE ratios. That’s because they are valued based on their dividends. With near-record low-interest rates, they have thrived. I think the selloff in utilities occurred because the sector is overbought. 

The worst sector on Tuesday was consumer staples which fell 1.79%. That makes it look like Tuesday was a ‘risk on’ day, but the overall market disagreed. Investors started off the day optimistic. But by the end of the trading session only the communication services sector ended positive as it was up 17 basis points.

Treasuries’ Explosive Rally

A few weeks ago, I was correct to go bearish on stocks but incorrect to be bearish on treasuries. Even though I have been pessimistic on the economy, I thought treasuries were pricing in too much weakness. That’s an awkward situation to be in as an investor. That's because I agreed with the premise of the rally. My main misstep was underestimating the effect of the global rally in government debt. Which has been catalyzed by the borderline global economic recession.

The rally in Treasuries has persisted while stocks have fallen, showing us the true winner in this battle. It made no sense earlier in the year for stocks to be rallying so much while treasuries priced in weak economic growth. The 10-year bond yield is shockingly low. It is now at just 2.24% which is 18 basis points below the Fed funds rate.

As you can see from the chart below, the 10-year yield is about 12 basis points below the 3-month bill’s yield. That’s the largest inversion of this cycle. 

The 10-year yield is at its lowest level in 19 months. This is a global rally in government bonds as the German 10-year yield hit its lowest level since September 2016.

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The 2-year yield is 15 basis points below the 10-year yield as it is at 2.09%. 

2 Year Yield - the Lowest level since early last year. 

The 2-year yield has peaked which means the business cycle is likely over. It is screaming that the Fed will cut rates this year. I can’t disagree with that notion any longer because of the latest disappointing economic reports. Investors now see a cut happening in September as the Fed will likely guide for a rate cut at its June 19th meeting.

Fed funds futures market is pricing in a 10% chance of a cut in June, a 55.5% chance of a cut in September, and an 83.7% chance of a cut this year. If the Fed doesn’t guide for a cut this year, the stock market will revisit the lows of last December. 

The economy is in worse shape now than late last year and the trade war looks worse as there are more tariffs. Fed being too hawkish again would be the final nail in the coffin for stocks.

Huawei Files Legal Action Against U.S.

In March Huawei filed a lawsuit that stated the law banning government agencies from buying Huawei’s products is unconstitutional. This week Huawei filed a motion for summary judgment. It will take a few months to get a decision on this motion. 

Eastern District of Texas court has a hearing scheduled for September 19th. This dispute is a small part of Huawei’s fight with the U.S. government which itself is a part of the trade war with China. Some economists are predicting that even after the tariffs are eliminated, the tech war with China will rage on. At this point, anything is possible.

Stock Market Reversal - Conclusion

Economic reports and the bond market are both leaning towards potentially calling for a recession in the intermediate term. Two reasons why you don’t hear a recession discussed that often is because the stock market is less than 5% from its record high. And also because most labor market stats are still solid. 

It’s possible that if the stock market falls further, President Trump will drop the tariffs creating a mini-economic burst.