The Brexit vote is over and the UK is going to leave the EU. The Dow lost -610 points, S&P -76 an Nasdaq -202. It was a really ugly Friday but the major indexes stopped right at strong support. Will this decline be a one day wonder?
There is a good possibility we could see some follow through selling at the open on Monday. I would not expect it to be as heavy as Friday but it could take the S&P down to 2,025 or even the 200-day average at 2,020. I would expect a rebound from those levels.
There is also the slim possibility we could see a positive market at the open but that would be a wildcard. The problem is the impact of currencies overseas. Japan and China could react to the currency fluctuations by intervening in the market. That could provide further volatility.
The dollar is likely to continue rising and the British pound should continue declining. However, the pound is already at 31-year lows so there could be an oversold bounce at any time.
The rising dollar is going to depress commodities and that could weigh on energy equities and mining stocks. Banks and financial stocks could also be a trouble spot as interest rates decline and questions about post exit operations continue to swirl.
The market this week will be a series of eddies and whirlpools like you see in the water behind a boat. The British exit from the UK is like a super tanker moving past a bunch of moored sailboats. Some stocks, sectors and markets could be shaken severely and others will just bob up and down on the waves.
I warned last week to "batten down the hatches because a storm was coming." The storm was intense but once they pass the weather normally turns calm again. The big question is whether the storm has passed or is it still in progress? We will know that at the open on Monday.
The Dow Transports crashed through support at 7,500 on worries over future European travel restrictions. Once the UK leaves, they will not have the same unrestricted travel they currently enjoy as an EU country.
The decline in the transports is troubling for the Dow because Dow Theory suggests the Dow cannot move higher without confirmation from the transports.
Crude prices fell -5% to $47.50 but it was mostly on the 2% spike in the dollar rather than worries over energy dealings in Europe. However, the -8% drop in the pound with some analysts saying it could turn into a 15% decline, means it will be significantly more expensive to buy oil in dollars. Converting pounds to dollars to pay for oil is going to be very painful.
The dollar-oil relationship is clearly visible with oil turning sharply lower while the dollar moved sharply higher last week. We could easily see oil prices under $45 as the dollar moves higher.
Gold exploded higher to $1,362 intraday in a safe haven trade but the spiking dollar caused that gain to evaporate to close at $1,319. This will be a complex trade in the weeks ahead because the rising dollar is going to be a problem. Gold prices are at two-year highs despite the dollar impact.
The Semiconductor Sector ($SOX) declined -6% from an 11-month high on Thursday to a 6-week low on Friday. Investors are worried that a 10% drop or more in the pound will slow purchases of tech equipment into the UK almost immediately. Overnight everything coming into the country costs 10% more in dollar terms. Several tech firms derive more than 10% of their revenue from the UK. Hewlett Packard Enterprise (HPE) gets 13% of their revenue there. This is a knee-jerk reaction but quite possibly a real problem.
The banks and financial stocks were crushed because most of the money center banks have big operations in the UK. Goldman Sachs gets 26% of their revenue from the UK, JP Morgan 15%, etc. If the EU imposes some harsh penalties on the UK exit the banking sector could bear the brunt of the sanctions. Currently there are limited, if any, banking restrictions between EU countries. Stepping out of the EU causes all those country-to-country problems to reappear.
The broader NYSE Composite Index ($NYA) failed for the third time at 10,625 before falling back to a 3-month low. This broad index has support at 10,000 and a failure there could put it into free fall. This is a good representation of the broader market since it contains stocks of all sizes and sectors.
The flight to safety trade sent billions in cash into the German bund and forced the yield down to -0.05%. Cash will continue to flow out of the UK because of the future uncertainty.
FYI: Germany will have to pay the EU an additional $3 billion a year to make up for their share of the budget once the UK no longer pays its $20 billion a year into the EU coffers. This is an added incentive for EU regulators to extract a financial penalty from the UK in future business relations.
The percentage of S&P stocks trading over their 50-day average fell to 34% after Friday. The percentage over the longer 200-day average fell to 62%. The percentage of stocks still holding a point and figure buy signal fell to 60%. None of these indicators are in critical territory yet but they are moving south at a rapid rate.
However, the percentage of Nasdaq stocks over their 50-day average has fallen to a 4-month low at 35.78% with the MACD negative and declining. This suggests the tech sector could see some additional weakness.
There is no way to know if the Friday market crash was a one day wonder until the smoke clears next week. About the only thing we can be certain of is that there will be volatility. For those that took my advice last week to take a vacation from trading until Monday, you saved yourself a lot of panic and frustration. If the market dips to 2020-2025 on Monday I would be a buyer. I am actually a buyer on any rebound on Monday but I am still looking for some margin selling that could push it temporarily lower.
Enter passively and exit aggressively!
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