Market Stumbles As Stimulus Hopes Fade


Over the past couple of weeks, we have discussed the market rally from the recent oversold lows.

“The Federal Reserve needs ‘more stimulus’ to monetize the underlying debt issuance for investors. Such is how, ultimately, liquidity gets into the markets. With markets only about 3% away from all-time highs, there is really nothing to stop it from getting there unless stimulus talks break down once again.”

Unfortunately, the latter happened as the stalemate between House Democrats and Treasury Secretary Mnuchin continued. While both the Treasury Secretary and the President have signaled they are open to a much bigger stimulus package, the House’s Speaker isn’t budging off her demands for state bailouts. Neither is Senate Majority Leader Mitch McConnell, who has already stated he will not take up any House bill. He stated he would put a roughly $500 billion targeted relief bill to vote in the Senate as soon as next week. That bill is also doomed.

However, even without a stimulus package, the market rallied nicely from recent lows. The good news is the bit of trading sloppiness last week allowed the market to start working off the overbought condition. While we could see some additional weakness early next week, the downside risk is fairly limited going into the election.

Conditions Are Less Favorable

As shown below, both the 20- and 50-dma’s sit just below current levels. Those averages should act as initial support. Below that support are the recent lows, which will likely contain the market within the current range. Such would entail a roughly 8% decline from current levels and certainly well within the context of a normal market correction.

However, a break of that important support will quickly find the 200-dma, which is currently about 11% below current levels. As we will discuss momentarily, a “contested election” could certainly provide the catalyst for such a decline.

The fuel for a bigger decline remains this week. With speculation ramping up again, the risk/reward in the short-term has become less favorable. Call option buying remains extremely elevated relative to historical norms and exacerbates market declines when those positions are unwound.

On a longer-term basis, we remain concerned about the dichotomy of signals from the market. Negative divergences of RSI,  the number of stocks above their respective 200-dma, and the more extreme monthly overbought condition are concerning.

The previous extensions over the last decade have led to decent corrections. Could this time be different? Sure, anything is possible. However, as investors, we want to remain focused on the “probabilities.”

While the market seems assured that more stimulus is coming sooner rather than later, one risk facing the market may be a “contested election.”

 

An Election Night Risk

Over the last few weeks, we have discussed much of what happens to the stock market both pre- and post-Presidential elections.

However, there is the potential for a delayed election outcome this year, which could rattle the stock market. As noted by Morgan Stanley via Zerohedge:

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