The news media caught Ebola fever last week with headlines about the virus infecting the airwaves and fueling fears of an outbreak in the U.S. While Ebola remains a lethal disease the odds of a large scale infection in the U.S. are unlikely. Unfortunately the media's white hot focus on Ebola did not help investor sentiment. Meanwhile stocks reacted to ongoing worries over a global economic slowdown and individual names moved on earnings results.
Volatility was the name of the game for stocks. Since the September Alibaba IPO peak the Dow Jones Industrial Average has seen an intraday drop of almost 1,500 points. The S&P 500 almost hit correction territory with a -9.8% pullback from intraday high to intraday low. The NASDAQ did tag a -10.7% correction on an intraday basis. These sharp moves has fueled a massive spike in the volatility index (VIX), which has risen from near 11 in late September to an intraday peak above 30 this past week. The VIX has not been this high in years. Investors searching for safety rushed into U.S. treasuries and the yield on the 10-year bond dropped under 2.0% for the first time since 2013.
Chart of the Volatility Index (VIX)
Chart of the U.S. 10-year bond yield
Stocks did see a sharp two-day bounce on Thursday and Friday. Helping fuel gains, aside from bears covering positions ahead of the weekend, was help from central banks. Maybe I shouldn't say help. The correct term might be encouraging talk. James Bullard, President of the St. Louis Federal Reserve, offered dovish comments suggesting that maybe the Fed should postpone ending their current QE program, which is set to expire at the next meeting in late October. While his comments may have helped investor sentiment Bullard is not currently a voting member of the FOMC. Markets also responded to soothing words from comments that the European Central Bank was nearing some form of QE program in the next several days. We'll talk a little more about that in a bit.
After the week was down the S&P 500 still posted a loss, marking its fourth weekly decline in a row. It's the worst decline in over three years. The Dow Industrials ended the week with a -1% loss and is down -1.1% for the year. The NASDAQ and S&P 500 both trimmed their 2014 gains. The small caps delivered a big bounce but the Russell 2000 is still negative for the year. Transports were some of the best performers with the Dow Transportation average up +3.2% last week and up +10% for the year. The SOX semiconductor index also performed well with a +2.4% gain last week. The U.S. dollar posted its second weekly loss in a row but that failed to help crude oil. Oil prices plunged another -3.6% and oil is now down -16.6% for 2014.
Worries about economic weakness in Japan, China, and Europe helped fuel the stock market sell-off. Yet so far the economic weakness is not showing up in America. We did see a disappointment in the New York Empire State manufacturing survey for October, which dropped from 27.5 to 6.2. Yet the Philadelphia Fed business outlook survey only dipped from 22.5 to 20.7 when economists were expecting a drop to 19.8. Numbers above zero suggest economic growth. We also saw U.S. industrial production rise +1.0% in September following a -0.2% decline in August. Analysts were only looking for an improvement of +0.4%.
Some of the housing data was encouraging. New building starts improved from an annual pace of 957,000 to 1,017,000 in September. Single-family housing starts rose from 639K to 646K. We also saw mortgage refinance applications surge +10.6%, a four-month high, thanks to falling mortgage rates. One area of concern were the homebuilders themselves. The latest survey of homebuilders showed the National Association of Home Builders sentiment drop from 59 to 54 when pundits were expecting confidence to remain steady.
One area of confidence that has been strong is consumers. Gasoline prices at four-year lows always helps consumer confidence. The latest survey of consumer sentiment showed an improvement from 84.6 to 86.4 when economists were expecting a decline. The current reading is a seven-year high. The slowly improving job market has helped boost confidence. Last week we saw initial jobless claims drop to a 14-year low at 264,000.
Overseas Economic Data
Japan reported their industrial production numbers dropped -1.9% last month. That was worse than expected and below the prior month's -1.5% decline. In China we saw new inflation numbers with consumer price inflation up +0.5% while wholesale producer price inflation down -1.8%. China is also expected to report their slowest growth in several years. Estimates are coming in around +7.2% GDP growth. That is below the official target of +7.5%. Unfortunately China's growth has been steadily slowing down from +10.5% in 2010 to what could be less than +7.5% in 2014. China reports their next GDP estimate on Monday, October 20th.
We already know Europe is slowing down. The 18-nation Eurozone is heading toward its third recession in the last six years. Germany has long been the engine of growth for the EU but now that engine has stalled. The latest investor confidence ZEW survey in Germany dropped from 6.9 to -3.6, which was significantly worse than expected. This helped send the German DAX (stock index) to a new 52-week low. If a slowdown in growth isn't enough to scare you then Europe is also facing a looming threat of deflation. At the same time the European credit crisis looks poised to flare up again. Greece is starting to make headlines and threatening to leave the EU. Yields on Greek 10-year bonds soared from 6.6% to over 9% last week before settling at 8.9%.
All of these negative pressures in Europe is pushing investor money into the safety of bonds. The United Kingdom's Telegraph news agency noted that yields on the 10-year German Bund fell to an all-time low of 0.72%. That is the lowest level ever seen in a major European nation "in recorded history." According to Andrew Roberts, the credit chief at RBS, "This is not going to stop until the European Central Bank steps up to the plate. If it does not act in the next few days, this could snowball."
Comments from ECB officers last week that the central bank would start purchasing asset backed securities soon did help alleviate the market sell-off. Yet ECB President Mario Draghi has been hinting at some form of QE program for years and never really committed. Now it would appear that investors are tired of all the talk and want to see more action. If we don't see a satisfactory response from the ECB this coming week it could ignite the next sell-off in European stocks.
The S&P 500 lost -1.0% for the week. That cut its 2014 gains to just +2.0%. On a closing basis the index is down -7.4% from its September high. Yet on an intraday basis it's down -9.8%. That's probably close enough to consider it a -10% correction. Unfortunately last week's decline saw the S&P 500 breakdown under technical support at its simple 200-dma and the 1900 level. Now that this support is broken it's new overhead resistance. So guess where the bounce stalled on Friday? It stopped just shy of the 1900 mark.
Technical traders will also note that the oversold bounce in the S&P 500 stalled near its 38.2% Fibonacci retracement. The 1900-1950 zone is where any bounce is going to run into trouble. According to Carter Worth, the Chief Technical Analyst at Sterne Agee, this area in the S&P 500 is the "kill zone" for the oversold bounce.
I would focus on resistance at 1900, 1925 and 1940. Support is probably 1850 and 1820 but it needs to be retested before having any confidence in these support levels. That's especially true since the average market correction is about -13%, which would mean a drop to the 1750 area, which is pretty much around the February 2014 lows.
If we see the S&P 500 put in a double bottom near 1820 or even a higher low then we can have more confidence that the correction might be over.
chart of the S&P 500 index:
Weekly chart of the S&P 500 index
The NASDAQ composite lost -0.4% for the week. It's 2014 gains have slipped to +1.9%. Last week saw the index's intraday pullback reach -10.7% from its September highs. Thursday's bounce produced a bullish engulfing candlestick reversal pattern but the bounce is stalling at resistance.
Broken support near 4300 and its simple 200-dma is now overhead resistance for the NASDAQ. You can see on the daily chart how the NASDAQ's bounce also failed at the 38.2% Fibonacci retracement of the sell-off. I suspect the 4300-4400 zone could be a challenge for the bulls.
chart of the NASDAQ Composite index:
Intraday chart of the NASDAQ Composite index
After underperforming the rest of the market for weeks the small cap stocks finally bounced. The Russell 2000 delivered a +2.75% gain last week. The $RUT is still down -7% for the year. Sadly last week's bounce does not invoke a lot of confidence. The rebound stalled at round-number resistance near the 1100 mark.
All of the $RUT's major moving averages have rolled over or they are starting to for the longer ones. This is suggesting a potential trend change on a larger scale.
I would hesitate to put any faith in any Russell 2000 rebound until we see better evidence of a bottom.
chart of the Russell 2000 index
Weekly chart of the Russell 2000 index
Economic Data & Event Calendar
The week ahead is relatively quiet when it comes to economic data. We'll see plenty of data out of China on Monday. In the U.S. we'll get a couple of regional Fed surveys on Thursday. The real headlines should be earnings.
Apple (AAPL) will make headlines when they report on Monday night. Altogether more than 20% of the S&P 500 will report earnings this week. More than one third of the Dow Industrials will report. We could see a lot of volatility for individual stocks.
Overall the Q3 earnings season has not been that bad. The average earnings growth so far has been about +5.1%. That's better than consensus estimates for +4.1%.
Economic and Event Calendar
- Monday, October 20 -
Apple (AAPL) reports earnings after the closing bell
China Retail Sales
China Industrial Production
China GDP estimate
- Tuesday, October 21 -
Existing Home Sales
- Wednesday, October 22 -
Consumer Price Index (CPI)
- Thursday, October 23 -
Weekly Initial Jobless Claims
Chicago Fed National Activity survey
Kansas City Fed manufacturing survey
- Friday, October 24 -
New Home Sales
Additional Events to be aware of:
October 29, FOMC policy update
October 30, Q3 GDP estimate
If we look at the big picture for the economy the sell-off in crude oil is a bullish tailwind for the economy. Worldwide the price of crude oil has plunged -27% or $31 to about $84.50 a barrel from its 2014 highs. According to MSN.com, this is terrible news for oil producers who are losing almost $3 billion in oil revenues every single day. On the other hand it's great for the global economy because consumers and transportation companies (trucks, trains, and airlines) are all pay less for fuel. That means the world can spend that $3 billion on something else besides fuel every day. Citigroup estimates that low fuel prices could provide more than $1 trillion worth of stimulus to global economies and the average consumer will save $600 a year.
Ebola Virus Outbreak
Ebola will remain a top headline for news agencies. It's a horrendous disease so it's easy to generate fear. Yet a major outbreak in the U.S. is unlikely. There is still a huge risk in Western Africa but the media is not telling you that some countries have managed to contain the outbreak. A recent W.H.O. report noted that Nigeria and Senegal have apparently managed to stop the spread of Ebola but you don't hear about it because it doesn't sell the news. Speaking of the World Health Organization, they have admitted to several mistakes in responding to the Ebola outbreak in Africa. The U.S. Centers of Disease Control (CDC) has also confessed to making mistakes.
Thus far the U.S. has only seen a small handful of people diagnosed with the virus and only one has died. When you consider we are a very active and mobile society of more than 318 million people and we're still allowing airplanes to fly back and forth from West Africa to the U.S. it's amazing the spread of Ebola hasn't been worse. Investors should not worry about this story unless it gets materially worse. The current strain of Ebola has a 70% death rate. So we might see a few more deaths, which is terrible but you don't see headlines about the tens of thousands of people who die from the flu every year. Personally I suspect the government is not telling us the whole truth about how risky Ebola is. The story has been that it's hard to catch and we shouldn't worry. Yet new federal protocols for treating Ebola patients will have health workers using protective gear with absolutely no skin showing.
The Ebola story has just been an excuse or a catalyst to help fuel the market pullback when the market was already tired and needed a correction. The real challenge is the global growth picture, which is slowing.
Another factor behind the stock market sell-off is probably the end of the Federal Reserve's QE program. When the Fed ended QE1 the market dropped about 17%. When they ended QE2 the market fell about 13%. Today the Federal Reserve's balance sheet is $1.5 trillion higher than it was at the end of QE2. As we near the end of QE3, which should be announced at the next FOMC meeting on October 29th, we have one more excuse for investors to sell stocks.
Trading can be a complicated game. Part of the game is investor psychology.
Everyone has known that the market was due for a pullback. People talk about how they wanted to see a pullback and hoped for a correction so they could take advantage of the weakness and buy stocks. Market pundits point to all the previous market selloffs as opportunities for you to have jumped in. Yet when we are in the middle of the selloff and stocks are plunging faster than you might expect then suddenly nobody wants to buy anything. Suddenly everyone is worried about a market crash. Suddenly stocks look too risky and we see money move into the perceived safety of bonds.
Be mindful of your emotions and use stop losses to help manage your risk.
The market's sell-off from its September high has done a lot of technical damage. It might take a while to repair that damage. I do think this pullback is an opportunity but that does not mean we have to jump into new bullish positions tomorrow. We should wait for more evidence that the correction might be over before putting new capital to work.
I previously suggested that we might see a market bottom in the second half of October. That is the next two weeks. Be patient.