Friday's -2.5% decline was the biggest drop since the Brexit vote and there is more to come.
The S&P futures are down -15 points on Sunday night and the Asian markets are off 1.5% to 2.2% in early trading. The fear that hit the markets last week started with Mario Draghi when he refused to extend QE as expected and made some hawkish comments. Analysts fear the ECB, BOJ and PBOC have reached the end of their stimulus cycle. The stimulus efforts have been of little help to inflate their sagging economies and the $13 trillion in negative yield government bonds is hurting the economy. Many companies depend on a guaranteed return from investing in government bonds. Without any yield there is nothing to buy unless you move down the credit spectrum and many corporations, retirement funds, etc, are prohibited from buying non investment grade paper.
There is a sudden consensus that the Federal Reserve may have tipped their hand to Draghi indicating they were going to hike rates in September. This caused Draghi to hold off on extending QE because that would have weighed on the euro while a Fed rate hike will make the dollar stronger. That will further harm companies doing business internationally.
The Rosengren speech on Friday morning was seen as a red flag warning the Fed was prepared to act. The market added up all the pros and cons for the week and suddenly decided the Fed was likely to hike rates and investors ran for the exits.
Portfolio managers were already restructuring portfolios after Labor Day in preparation for their October 31st fiscal year end. On Thursday, quite a few stocks showed sudden and unexplained selling. I mentioned at the time it could be the start of a trend change for the market.
Friday's market selloff was the result of everybody heading to the exits at the same time. Investors were so convinced the breakout from that 8-week range was going to be to the upside, they were excessively long. When the Fed news took center stage at the same time portfolio managers were trying to sell their winners and raise cash for a potential October low, the sellers outnumbered the buyers by 10:1 and it was ugly. Also, the coming week is a quadruple witching option expiration and managers normally cleanup all their option positions on the week before expiration. Everything came into focus on the same day.
Looking forward to next week the event to watch is the speech from Fed governor Lael Brainard on Monday at 1:PM. She is the most dovish person at the Fed and a change to a more hawkish tone would be a clear signal the Fed is going to hike rates. Because the economic reports have been so bad, the market assumed there would be no September hike. In order to hike in September the Fed had to send out several speakers to talk about "sooner rather than later" hikes and full employment. The Fed tries to telegraph its plans in order to avoid a market shock. If Brainard is hawkish it would be a clear signal. Brainard's speech was unplanned and just announced late last week. She is also not a regular speaker so the sudden announcement caught everyone off guard.
The S&P has support around 2,100 with Friday's close at 2,127. If the 2,100 level does not hold, the next support is 2,045 and 1,990.
The Dow crashed below support at 18,350 and is closing in on 17,925-18,000. A failure to hold at that level targets 17,135-17,400.
The Nasdaq set a new high on Wednesday and then declined -3% over two-days. There is no material support until back below 5,000 but that does not mean that is where it is going. With the $SOX and $BTK in the dumps the Nasdaq has lost two of its support pillars. Apple is crashing and the FANG stocks rolled over after their big gains last Tuesday. It could be a rocky week for the Nasdaq.
The small cap Russell 2000 has not fallen out of its congestion range but it did fall back to the bottom of the uptrend support channel. The Russell has strong support at 1200-1205 and I would expect that to hold unless the market goes into panic mode and starts heading for a real correction. We were due for a 3-5% drop and we saw an average of -2.5% on Friday. If the decline exceeds 5%, it could accelerate quickly because nobody is ready for that.
All of the Fed speakers are clustered on Monday because the 7-day quiet period before the FOMC meeting begins on Tuesday. Brainard is the key speech.
The economic reports that matter are clustered on Thursday and it could be a noisy morning. The PPI, Retail sales and the Philly Fed Manufacturing Survey are the most critical.
For the last several weeks, I have repeatedly warned about being overly long and recommended keeping some cash on hand and building a shopping list of stocks you would like to buy on a dip. The dip is here and now the challenge is picking the bottom. It could be any day this week or it could be weeks from now. We just have to wait and see. The key to buying stocks in a correction is to pick a price where you would be comfortable owning the stocks/options and then wait. If that price appears, you take the plunge. Maybe you only buy half a position and then if the stock dips again you buy more. If it rises instead of dips then you at least have half a position and you can scale into a full position on any future volatility.
Secondly, if you are comfortable owning XYZ stock at $50, down from $65, then just buy it at $50. The odds are good it is not going much lower after that big of a decline. Even if it does, you already planned on being "comfortable" at $50 and long term the dip will be erased if the fundamentals were sound.
Send Jim an email