Many traders woke up this morning in utter dismay when they saw the DOW futures trade down by more than 740 points. The fear of coronavirus cutting into corporate revenues across the globe is now becoming a reality.
Companies like Apple, FedEx, and Starbucks have revised earnings lower because of the coronavirus pandemic.
When stocks experience a sell-off of this magnitude, it’s important for you to know which are the key levels of support and resistance.
And while the charts below were put together last night, the analysis I’m about to share with you—still rings true.
The higher they climb the harder they fall. Technology-led the bulls last year. So it’s no surprise the QQQ crashed out harder than the other indices last week.
QQQ Hourly Chart
When I step back and take an expansive view of the market, I don’t think the pain is over. Financials flashed warning signs long before Friday. Gold and bonds clearly said there were issues.
Rather than focus on what we already know, this week’s Intermarket analysis looks at what sectors will provide us the answers we need. Relying on the wrong charts for your forecasts could wipe out all your gains.
Everyone is focusing on the headline-grabbing markets – the S&P 500, the Dow, the Nasdaq 100. That’s all fine and well. Most investors have money tied up with them in some way or another. But those only tell you where you are, not where you’re going.
For that, we need to dive into the tech wreck.
I can’t say for certain what it was that woke up investors to the real dangers in tech valuations. But it appears they all got the message at once. Semiconductors became the first casualties.
With the Coronavirus hitting supply chains as well as Chinese economic growth, semiconductors held on as long as they could. Last week investors decided that between the Apple announcement of a revenue miss and an increase in infections, it was time to pull back.
SMH Hourly Chart
I’m actually amazed this area held up as long as it did. Semiconductors are notorious for boom and bust cycles. The one-time innovation matured into a commoditized space. With so much of the supply chain flowing through China, this index should have fallen weeks ago.
In fact, I think this area holds more risk than most other sectors in the coming months. Don’t be surprised to see violent swings in names like AMD or INTC.
If you wanted to make money in 2019, you dropped cash into the major indices. Small caps lagged for the majority of the year, only breaking out of their range on the final end-of-year ramp. That put indexes like the QQQs in unsustainable territory.
Normally, small caps outperform during booming economic cycles, powered by global expansion. Their diverse customer base relies on revenue growth to push prices higher. Our current rise has been marked by bottom line improvements driven by cheap money. Business lending remains tight for smaller companies.
So why would the IWM only be down 0.77% compared to 2.83% for the QQQ and 1.44% for the SPY?
IWM Hourly Charts
It comes down to risky money. Last year, money took risk by flooding into the QQQs, driving it up 42.10% compared to 21.06% for the IWM. Normally, money that seeks risk spreads out more evenly. Even the high yield debt market (HYG) didn’t make it up double digits last year.
This leads to two conclusions. First, there isn’t as much money to flow out of small caps as tech. Second, from a relative value standpoint, if risky money needs to find a new home, small caps make the most sense. No one wants to dump risk money into the debt market when yields are this low. They want to get more for their investments.
So, if we see the small caps start to crack along with the rest of the market, that is a signal things are about to get very bad.
Most of us are aware of the outperformance of bonds and gold last week. Gold certainly took the prize, breaking out past old highs and starting another leg of its bull market. Bonds didn’t come out as strong, but still managed to break through their recent highs.
Yet, the oddball out there was the US Dollar. Normally, money hides in the US Dollar for safety when stocks sell off. This doesn’t always happen since higher bond prices can lead to a lower dollar. However, it’s decline last week was notable.
UUP Hourly Chart
This could just be a pullback before the dollar index reaches $100 (par value) on a basket of currencies. However, this could also be the first warning sign the Fed is losing control.
Yes, the central bank wants to weaken the US dollar. However, all they’ve managed to do is make bonds more expensive. With treasuries getting more overvalued by the day, we could be setting up for a crash in bonds. This could spike yields and the dollar at the same time.
Gradual moves don’t always hurt the market. Fierce swings in a short period of time can create a cascade failure across markets.
Equities and the VIX have an inverse relationship. When equities rise, the VIX tends to fall. If you see the VIX rising, it usually means equities are heading lower. The VVIX measures option demand on the VIX.
VIX Hourly Chart
Right now both are up a good amount compared to last year. The main levels we need to pay attention to are $20 in the VIX and $115 in the VVIX. Once we start to get to those areas, we should start looking for a bottom.
VVIX Hourly Chart
That doesn’t mean that we can’t bottom before then. Look for an intraday reversal on the VVIX with confirmation on the VIX to tell you when things are changing.
Every Monday I release my highest conviction trade idea aimed at hitting 100%. There’s still time to get yours before the market opens Monday morning.
Is the market starting to crack or is this just one of those legendary buy the dip opportunities?
Here’s my take—despite a frothy market propped up by easy money, equities aren’t as overvalued as you might think. With the current price to earnings ratio at 23.77x, it fits within a historical trend that started back in the 1980’s.
Long before the Great Recession, valuations climbed steadily through the 80’s and 90’s. We only got in trouble when clear bubbles formed, and even then it could take years to play out.
Our recent growth has been shallow but predictable. Sure it’s exacerbated by low interest rates. However, most estimates show they boosted stocks by 20%.
The real danger lies in government debt. That’s where we start the jump this week; not on the obvious equity decline, but the lack of a bond breakout.
Most of us know that with higher bond prices and lower yields, savers hurt the most. But here’s something you probably weren’t aware of. Right now, the 10-year real interest rate is -0.15%.
Yes my friends, investing in U.S. government debt actually costs you money if you hold it until maturity.
So why would people keep at it? Central bank policy. Governments around the world continue their race to the bottom in hopes of devaluing their currencies. While many claim victory, the recent distribution of wealth has favored a smaller percentage of the wealthy than the broad economic indicators would suggest.
Last year, the Federal Reserve published data that noted how the top 1% share of wealth continues to increase at the expense of the next 9%, as well as the acceleration lower of the next 90%. That becomes somewhat evident when you look at the political environment juxtaposed against the increasing wealth of Jeff Bezos or Mark Zuckerberg.
And yet, the Federal Reserve wants to continue to push rates even lower. But their influence may be waning. Compare the breakouts of the TLT to GLD.
TLT Daily Chart
Bonds barely broke out above their previous highs and certainly had trouble sustaining that momentum throughout the day. Compare that to the GLD performance.
GLD Daily Chart
Not only did gold break out, it did so with a vengeance.
This can best be summed up through the outlook for politics in the coming weeks.
By the time you read this, the Nevada primary will already have finished. While the winner may be obvious, the likelihood of a contested convention frightens markets. Traders and investors want certainty. A protracted fight that fractures one of the major political parties won’t soothe their fears.
Initially, markets discounted Bernie Sanders as a real contender given he didn’t win 2016. However, the closer we get to the convention, the more worried they become. Even if you like Sanders’ policies, the enormous lift they ask will take years to implement, much further than market participants are willing to look. That means the more likely a left-wing candidate comes to the presidency, the more likely markets will spook.
Super Tuesday adds a wrinkle into the mix as Michael Bloomberg jumps into the race, betting on data science to beat out his rivals. While he may do just that, I guarantee there will be sore feelings if he pulls one out through maneuvering through the system.
As candidates drop out of the race, we’ll likely see markets stabilize a bit more. But as we get into the summer months, volatility will start to expand if history has any say in the matter.
Two black swans fly on the horizon. The first is the somewhat known Coronavirus epidemic. History says that it’s likely to flame out. But we have no way to know for certain. Companies from Apple to Tesla are already warning of supply chain issues.
We’ll likely get drips of information week after week. Most of it won’t do much unless it increases the likelihood of spreading globally or further disrupting the Chinese economy.
That’s likely more of the reason behind the QQQ hard declines relative to the SPY or IWM last week. Many of the companies that make up the Nasdaq 100 will feel some impact from Coronavirus related issues.
The second concern takes us back to Thursday. We saw a decent swing in the market. And yet, even the pundits couldn’t come up with an excuse as to why that happened. Most of them blamed the algos.
What worries me is the lack of any storyline behind the move. We all know that markets are organic systems run by vast networks of computer interactions. Not everything will be apparent all the time. But when you have an intraday decline of that magnitude, and no one can even point to a cause with even limited certainty, that should put up a red flag.
I’ll be keeping an eye on the market these next few weeks, looking for any technical issues that could arise. And you can bet I’ll point them out to you.
Expected earnings dates listed in (…)
Stocks I want to bet against…
NFLX (April 21), AMZN (Apr 23), AMD (May 5), UBER (Jun 4), GOOGL (May 4), CVNA (Feb 26), COST (Mar 5), CMG (Apr 22)
Stocks I want to buy…
DIS (May 13), MJ (none), UNG (none), XLE (none), WDAY (Feb 27), LK (??), PTON (May 6), TWLO (May 3), TLT (none), UVXY (none), BYND (Feb 17), PBR (Feb 26), OLED (Feb 20), V (Apr 22), PINS (May 21), IRBT (Apr 28), SHAK (Feb 24), CVM (May 12), DPZ (May 20)
Monday, February 24th
Tuesday, February 25th
Wednesday, February 26th
Thursday, February 27th
Friday, February 28th
Humans, in general, are uncomfortable with uncertainty. Instead of accepting the fact that we don’t know everything, we’d rather be spoon-fed an explanation (whether it makes sense or not).
And if you follow the stock market… you’ll see it every day. One day the market takes off because the economy looks strong… the next it sells off due to fears of the coronavirus spreading…
But the global markets are complex, there are several moving pieces at work… do you really think we can sum up the reasons why it moves the way it does?
It almost feels like the narrative is written after the fact…
That’s why today’s lesson is so important.
I want to explain to you how to tell the difference between real news and fake. It’s not as easy as you might think.
There’s a lot of noise you must sift through in order to find the truth.
That’s not to say that news events don’t drive the market. Michael Bloomberg made billions delivering timely information to traders and investors.
He knew what was tradeable news and what was garbage. And if you can’t tell the difference, it’s costing you a lot of money!
First things first, let’s start off by categorizing the types of news.
Not all news is created equal. Some stories have lasting impacts, while others just stir the pot. I look at news in a few different segments.
Data – This includes Fed policy decisions, labor statistics, or any other measures that help us get a picture of what’s going on in an industry or the economy. Data points themselves don’t do much. Instead, analysts look at trends, which occur over longer periods.
Earnings (or other company announcements) – These are company-specific. However, some companies may give outlooks or commentary that looks at a bigger segment of the market.
Emotional – I lump in things like Trump tweets, Fed commentary, or anything that doesn’t contain much substance, but drives emotional decisions of investors.
Black swans – These unexpected events happen from time to time and throw the market for a loop. Coronavirus would be a good example, as well as the temporary Iran/U.S. conflict last year. Sometimes, they’re catastrophic like 9/11.
You would think that the ‘hard’ information from data and earnings would drive stock price movement immediately. Most of us don’t realize how long it actually takes to work. We see the reactions to earnings announcements and think that the two are tied together. In fact, most investors take weeks to digest and parse through the release.
The same thing goes with data. Outside of complete surprises, one data point won’t change investors’ minds. It takes months or longer before the boat finally turns.
In 2016, markets were in freefall during early February. During one of the drops, Morgan Stanley CEO and Chairman Jaimie Dimon came out and bought a whole bunch of stock. Pundits were quick to point out that this news ‘bottomed’ the market….except the market bottomed several minutes before that news first hit the wire anywhere.
Now, you could argue that someone had insider information. I would buy that. But let’s bet clear about something – Jaimie Dimon buying stock in his company didn’t stop the multi-week decline. It doesn’t work like that.
Newsworthy events like a Trump tweet or a Jaimie Dimon bottom only create impacts intraday. Rarely do they cover anything so expansive that it changes the way people think about investing. However, it certainly can influence intraday action.
In fact, most pieces of news will create some temporary impact intraday. Whether it lasts any longer is a function of two things.
First, the timing of the news in relation to the market. Jaimie Dimon’s call may have served as a catalyst for the market to bottom. But, it also occurred in a very oversold market that likely was getting ready to turn. If he made that same announcement after a rally, it probably wouldn’t have had the same impact.
Second, whether it actually changes anything. Initially, President Trump’s tweets could agitate the market by creating uncertainty. Now, traders look past it until they see any actions take place.
The taper tantrum is a perfect example of real news that’s masked in emotions. When Ben Bernanke hinted that easy money might be going away, markets took it very badly. The same thing happened when the Fed raised rates in December 2018. On the flip side, markets rallied on interest-rate cuts.
News that presents new data or new ideas will have a longer impact directly tied to that news. However, both nonsensical news and hard news can swivel the market intraday. That can create a cascading effect that drives long-term change.
You won’t know ahead of time how it all plays out. But, hard news has a higher probability of creating a lasting impact.
As traders, we need to be aware of both. That means creating a calendar of important data releases and thinking about how that impacts different stocks and markets. A great place to start is my weekly Jump on the Week newsletter. I point out the key data releases, earnings, as well as potential market-moving events.
In fact, I combine that information with chart analysis to deliver my Bullseye Trade of the week. How else do you think I could come up with one trade that has my highest conviction for the upcoming week?