Where Do Things Stand Now?

To be sure, it is rare to see the mood of the market swing from the depths of despair seen on Christmas Eve to the "happy days are here again" feeling of last week in such a short period of time.

To review, starting December 3rd, stocks began moving down - in a straight line - with the S&P 500 falling -15.23% in just 15 days. Then, in an abrupt change of heart, the index rallied +13.59% in the ensuing 17 days. Talk about a mood swing!

So, over the 32 trading days spanning December 3, 2018, through January 18, 2019, the S&P 500 traveled a total of 28.8%, which is a pretty impressive feat. Oh, and in the process, the recent rally erased the vast majority of the December debacle. Wow.

Looking at the action from a longer-term perspective, we see that the S&P fell -19.8% from the high-water mark set on September 20, 2018, through December 24, 2018 - and has since proceeded to recover a little more than half of the overall decline.

S&P 500 - Weekly

(Click on image to enlarge)

Given the intensity of the relentless decline and then the impressive bounce to the upside, which wound up triggering some "breadth thrust" buy signals along the way, the question of the day is, what the heck is going on and where do we stand now?

Trying to predict what happens next in Ms. Market's game can be challenging at best. So, instead of attempting to guess what comes next, I have been focusing on getting a handle on the meaning of the recent action. My thinking is that if I can come to understand the "why" behind these volatile moves, I can then look at history to try and find similar situations, which, might provide a clue in terms of what to expect next.

Thus, the first question we need to get our arms around is...

Why The Decline?

As we've discussed a time or two already, I believe there were three primary drivers to the market's dance to the downside. First and foremost was the fear of a Fed "overshoot" - i.e. fear of the Fed tightening monetary conditions too far and pushing the economy into recession. And lest we forget, the Fed actually has a long history of doing just that.

Next, there was the fear that the President's trade war with China would become prolonged. The big fear was the tariffs, which, as the textbooks tell us, are really just a tax on consumption, would wind up counteracting the good stuff that the tax stimulus had provided and the U.S. economy would wind up in recession.

And finally, there was the fear that the slowdown of corporate earnings and global economic growth would wind up gaining momentum to the downside, with the end result being, yep, you guessed it; a recession in the U.S.

So, despite the economic models I follow suggesting very little chance of a recession occurring in the good 'ol USofA, the fear was that the end of the current economic expansion might be artificially induced by these "policy missteps." And with the yield curve inching ever closer to inversion, the really big fear was that our policymakers were about to shoot themselves in the economic foot.

All About Fear

To be clear, the common denominator to all three issues here is the word "fear." Not the fear of what was actually happening in the economy or in corporate America, but rather the fear of what "might" happen in the future. And in my experience, this is the worst kind of fear as it allows traders to extrapolate the worst without any pesky evidence to back up the trade.

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Disclosure: At the time of publication, Mr. Moenning held long positions in the following securities mentioned: none - Note that positions may change at any time.

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