The Nasdaq declined -110 points for the biggest single day loss since February 3rd on no real news.
Houston we have a problem. The market crashed on no news and it was dramatic. Volume increased 1.5 billion shares to 7.574 billion. NYSE decliners were only 2:1 over advancers but Nasdaq decliners were 5:1 over advancers with volume 8:1 declining over advancing.
While the Nasdaq seemed to get all the attention there were some disturbing declines in the other indexes. We already knew the Nasdaq was weak and lagging the Dow and S&P. What may have caught everyone off guard on Friday was the breakdown in those leading indexes.
The Dow made a new intraday high at the open and held it until 11:00. When the clock struck 11 the selling appeared and it was brutal. Over the next 3.5 hours the Dow declined -239 points from its highs to set a new low for the week. After setting new highs for four days the bottom fell out on Friday with an outside day. (Higher high, lower low than the day before) An outside day generally signifies a change in direction. This is especially true with the index closes at the lows.
The same facts were true for the S&P with a decline from 1,897 to close at 1,865 for a -32 point drop from the high or -1.25%. The S&P had been leading all the indexes higher and was the strongest of the major indexes. For the S&P to collapse in this fashion is very troubling.
The Nasdaq declined -2.59% and the Russell 2000 -2.34%. The Nasdaq was led lower by almost every sector with 97% of Nasdaq stocks losing ground. However, the biotechs were again the biggest losers with a -4% decline and a new three-month low.
So what caused the drop? I believe it was three things. The first was the Nonfarm Payroll report, which came in with the perfect Goldilocks number along with upward revisions to the prior months. More on that later. The perfect jobs number with upward revisions means the Fed will continue down its taper path and could possibly accelerate it slightly if the jobs continue to grow. A faster end to QE means more risk for the market. Over the last four years no QE meant a declining market.
I believe the second reason for the decline was the level of the S&P. The index rose to 1,897.28 and less than 3 points from 1,900. I wrote last week about the resistance we were going to see as we reached the target numbers from the major analysts. The 1,900 level was the first range of targets and a very big round number. I believe some hedge funds had already planned to lighten up when we reached 1,900. With the "sell in May" cycle expected to be strong this year and Q1 earnings flat or worse, reaching the 1,900 level was an obvious exit point.
However, we did not reach 1,900 but the market really tried. It is a common practice to put your sell stops a couple points under the actual target to try and get a head start on the herd. On Friday the S&P spiked to 1,897 at the open and was quickly sold but dip buyers were ready. At 10:10 the index spiked again to 1,897 and was immediately sold. Dip buyers were again ready. At 10:30 the index again spiked to 1,897 and was immediately sold. However, the volume was much stronger and dip buyers did not appear. This is the three strikes and you are out rule. With the S&P stopped dead on 1,897 for the third time in an hour it became evident it was not going higher. Funds ready to sell stock on the rally to the round number high realized others were using the same strategy with a lower exit point and everyone headed for the exits at the same time. It was the equivalent of yelling fire on a crowded trading floor. Being a Friday just made it worse. Traders seeing the sell off and not understanding why suddenly exited their positions rather than hold over the weekend. Once the sell off gained some velocity the stop losses began to be hit and the rest as they say is history.
Lastly we could be seeing some additional tax selling to raise money ahead of the April 15th tax deadline. You take profits in the winners to pay taxes.
Sudden and unexplained declines tend to take on a life of their own and only the closing bell can halt the selling. The Nasdaq and Russell sold off harder because they were already the weakest indexes and the most overvalued. For instance the Nasdaq Biotech Index (IBB) has a PE of 190.
March Nonfarm Payrolls rose +192,000 compared to consensus estimates of +200,000. The range of estimates was 150,000 to 275,000. The February gain was revised up from 175,000 to 197,000 and January was revised up from 129,000 to 144,000. The revisions added +37,000 jobs and lifted the three month average up to 178,000.
The most important point of the revisions was the near erasure of the weather impact. This suggests the baseline for future months is higher and we should see gains over 200,000 per month. This is positive for the economy but negative for QE. While stronger job gains will eventually be positive for the market we have to get past the end of QE first. Like it or not the Fed is still supporting the current market with $55 billion a month in QE. The market will react negatively when that support is gone and the good jobs number today keeps the Fed on track for ending QE later this year and could possibly accelerate it if payrolls continue to climb.
The unemployment rate remained steady at 6.7% for the second month and average hourly earnings were unchanged. With the arrival of warmer weather more people began looking for jobs with 503,000 added to the labor force in March. That is the most in four months. Service jobs increased +167,000 with health care and social assistance gaining 27,000 and leisure and hospitality gained 29,000. Government payrolls were flat.
The number of workers employed part time for economic reasons rose +58,000 to 7.455 million. There were 2.2 million people not counted as being in the labor force because they had not looked for a job in the last four weeks. The U6 number of total unemployed plus marginally attached to the workforce declined -300,000 to 12.8 million.
The number of employed people as shown in the separate Household Survey rose +476,000 to 145.742 million. The household survey is not as precise as the establishment survey and is not widely reported.
The combination of the two employment surveys suggests the Fed may accelerate the QE taper to end in October if the employment continues to improve.
The economic calendar for next week is lackluster except for the FOMC minutes on Wednesday. This is the first week of the Q1 earnings cycle and the focus will be more on earnings than economics.
Alcoa is the first Dow component to report on Tuesday after the close. They are expected to report earnings of 5 cents. While everyone will be watching the actual impact to the market will be minimal. Most traders expect to be disappointed so the bad news is already priced in.
The biggest earnings for the week come from JP Morgan (JPM) and Wells Fargo (WFC) before the open on Friday. Wells Fargo is expected to earn 96 cents. JP Morgan is expected to earn $1.43. The banking sector has been a real mixed bag recently so anything is possible from these results. The banking ETF (XLF) has traded in a 75 cent range for more than a month. There is plenty of confusion to go around.
I hate to keep repeating a theme but the underperformance in the biotechs remains a critical hole in the market. The biotech index declined -4% on Friday and closed at a three month low. The minor bounce from early in the week was crushed.
This could be simply a continuation of profit taking, tax selling or serious rotation out of the sector and into something else. However, since there does not seem to be any specific sector standing out from the crowd I am leaning towards tax selling ahead of April 15th as the motive. Some of these stocks were up over 100% or more over the past year and they still have no earnings. With a PE of 190 for the sector the only way to justify buying these stocks was the hope one of them would come up with the cure for cancer or Alzheimer's. Prana Biotechnology had high hopes for their PBT2 Alzheimer's cure but study results released last week were worse than expected. The stock dropped -80% on Monday. That is a huge haircut and may have convinced investors in other research stocks to lighten up on their positions.
We may never know what is weighing on this sector but we do know that the sector is an anchor pulling the Nasdaq lower.
Eventually these stocks are going to each find a level where investors are comfortable with the risk and a bottom will form. Until that happens it is best to stay away from stocks that are losing 5% or more a day.
Unfortunately it is not just the biotechs that were crashing. When the market takes an unexpected plunge and traders are caught off guard they ending up selling what they can to remain liquid rather than what they want. This means the selling spreads to other highly liquid stocks and the downdraft accelerates.
In the Nasdaq list below it is worth noting that the biggest gainer on the Nasdaq was the SQQQ, which is the ultrashort QQQ. The 25th largest gainer on the Nasdaq rose only 59 cents. It was a really ugly day.
Look at the losers list. GOOG, NFLX, TSLA, PCLN, AMZN, WYNN, BIDU, GMCR and AAPL are all from different sectors but they are all known as momentum stocks. These are the crowd favorites and clearly the crowd was dumping them to raise money on Friday.
The start of earnings next week could also be a worry for investors. At the beginning of the quarter S&P was projecting earnings growth of more than 5%. After three months of harsh winter weather and more than 20 major storms those projections have declined to only +0.31% growth and earnings could easily go negative.
With the Fed tapering QE, suddenly earnings are beginning to matter. We have had a market over the last year where fundamentals did not matter as much as the $85 billion a month in QE that the Fed was injecting into the market. It was 1999 all over again with momentum stocks and IPOs soaring despite having no earnings. Suddenly earnings matter and we are not going to have any in Q1. The Fed is trying to slip out the door quietly with the taper program but investors are taking note.
Stocks like Twitter (TWTR), down -36% since early February, and LinkedIn (LNKD), down -29% since January, are seeing their losses accelerate. High flyer momentum stocks in other areas like 3D Systems (DDD) -33%, NetFlix -26%, SPLK -41%, FEYE, -48%, cloud computing highflyers like RAX -41%, CNQR -27% and other "fad" stocks are collapsing. With QE fading investors are no longer partying like it is 1999.
Everybody wants to discount the QE tapering as not material to the market. However, the taper was actually announced on December 18th to start on January 1st. Since January 1st the S&P is up ONLY .91% compared to 31% for all of last year then QE3 was in full bloom at $85 billion a month.
The market has never reacted well to the end of any Fed stimulus program. Since 2009 whenever a QE program ended the market tanked. What makes anyone believe that this time it is different?
With various Fed speakers constantly calling for a rapid end to the Taper the market is paying attention. The Fed may be trying to slip out the door quietly but with several squeaky hinges the market can't ignore the QE exit.
Yellen tried to calm the markets with assurances the Fed was going to remain on hold for a long time but the rebound was temporary. Everyone can see the end of QE from here and it is not that far away.
David Rosenberg, chief economist and strategist at Gluskin Sheff has noted more than once the correlation between QE and the rise in the S&P is better than 90%.
When the market decides to correct it normally starts with the momentum stocks and then widens into a broader attack until no sectors are left unsold. Margin debt is at a record of $465.7 billion and the momentum stocks are in free fall. This triggers margin selling and the remaining buying power in the account is eroded slowly to the point where investors are no longer able to buy the dips. They are struggling to decide what to sell to keep their remaining capital from eroding even further.
We are seeing the failure of multiple IPOs and that is another symptom the market is failing. With nearly 50 IPOs in March and 70 year to date the new issuance was soaking up all the speculative money in the market with offerings that had no earnings, high debt loads and weak sales. Companies were hoping they could catch the wave of enthusiasm before it crested. Many failed and their share prices are now under their IPO price. Investors have grown weary of the offerings and they have run out of funds.
The wild card here is the coming earnings. We know they will be bad since almost everyone has already warned because of the weather even if that was not an impact for them. Never let a good excuse go to waste. Q1 is shaping up to be a "kitchen sink" quarter where every negative available is thrown into the quarter to clean up the books. With everyone expecting the worst they might as well oblige.
If companies have done their job of under promising correctly they might even be able to over deliver and post a minor earnings beat. Whether investors will see through the earnings fog and recognize the deception is anybody's guess. Since the folks at S&P don't filter earnings through a truth detector we could actually see estimates rise during the quarter if the guidance warnings turned out to be too harsh.
If you are a bear on earnings today your risk is the low expectations. If you are bullish on earnings your risk is the kitchen sink additions. Since both positions have risks we may not see a material earnings rally into the end of April.
Guidance will be even more critical this quarter than in prior quarters. If guidance is just mediocre we could see a very rocky summer. With the economy in neutral at roughly 2% growth and currency challenges for all the international companies I will be surprised if guidance is strong. S&P companies get about 25% of their earnings from overseas and the currency fluctuations have been very bad over the last quarter. Numerous companies have warned of substantial hits to earnings from currencies.
The markets have turned negative despite the new intraday highs on the Dow and S&P on Friday. The outside reversals on both of those indexes are typically a bearish signal. Since the outside day happened from a new historic high the indications are even more bearish.
The decline in the Nasdaq to a new two month low and completely erasing the rebound that started on Monday is very negative. The rebound failed right at downtrend resistance and the sell off was dramatic. Initial support is 4,100 but the velocity of the decline suggests that level will not hold and we could retest the February support at 4,000.
The Russell 2000 small caps also collapsed. To have both the Russell and the Nasdaq collapse so sharply on the same day is very bearish for the market. The Russell did not break below last week's support lows like the Nasdaq did. The Russell actually appeared to try and hold at the level it set at 1:PM at 1,152 and rebound but selling right at the close ended the rebound attempt with a close at 1,154.
I don't want to imply it was bullish that the index held over 1,150 but it was encouraging. I still believe there will be follow through selling on Monday. The Russell did stop at the 100-day average but it failed to respect that average in February so it could have just been a coincidence. If we do punch through the 1,150 level the next material support is well below at 1,096.
The S&P was the strongest index last week with a multiday breakout to new highs. Friday's spike to 1,897 on three attempts was a concerted try to make that round number target at 1,900. There was simply too much supply waiting at that 1,897 level to punch through. By the third attempt any sellers with a higher sell target at say 1,898 or 1,899 had reset those targets to 1,897 and the high for the day. This is a common tactic. If your target can't be reached and time is expiring then lower your target to the high. When that level was hit on the third spike higher the remaining buyers were hit with an overwhelming volume of stock for sale.
The S&P is in pretty good shape relative to the other indexes. The 1,865 close is 15 points above light support at 1,850 and 25 points above strong support at 1,840. It would take a couple days of heavy selling to push the S&P below 1,840. That does not mean it won't happen but the odds are better we could see it linger above 1,840 until we see how the initial earnings are going to shake out. However, if the Nasdaq continues its crash dive it will drag the S&P along with it.
The Dow chart is almost as troubling for me as the Nasdaq. The Dow completed a picture perfect double top at the old high. For three days the Dow tried to get above that 16,576 high close from December 31st but was unable to do it. Each day had a higher intraday high than the prior day but selling always appeared at the highs. Friday's historic intraday high of 16,631 was made on the last attempt at 10:30 and when that big push failed it was lights out.
Failing at the historic high is one thing but doing it three days in a row and then three times on the last day is pretty convincing evidence of a significant amount of distribution.
Fortunately the Dow is well above decent support at 16,200 and 16,050. We can endure several more days of weakness before reaching critical support levels. The Dow only declined -.96% on Friday and the least of any major index. This suggests the big caps are still being used as a safe haven for storing money that would normally be invested in techs and small caps. Investors are looking for safety and liquidity rather than growth.
Goldman and Visa alone accounted for 80 points of the Dow's loss.
I also have a sneaking suspicion that the majority of the selling was done in ETFs. That is the only way you are going to get that broad of a decline in a large number of sector specific stocks. The internals were severely negative in ETFs related to the small cap, tech and biotech sectors. S&P Mid Cap decliners were 8:1 over advancers and the S&P Small Cap index saw 12:1 decliners over advancers. Volume in the Russell 2000 ETF (IWM) was 86.34 million shares compared to an average of 35 million on Wednesday and Thursday. Low volume on the rise but huge volume on the decline.
The Nasdaq Biotech ETF (IBB) traded 5.58 million shares on Friday compared to 1.8 million on Wednesday.
There is always the possibility a major hedge fund(s) were simply getting out of the market before a questionable earnings season and the "sell in May" cycle. Whether or not their exit triggers a mass exodus from the market over the coming week is unknown.
Don't forget that high frequency traders probably accelerated the move since their computers can take advantage of the trends and capitalize on them. A directional market it a gift to HFT traders.
I am bearish at this point. Until the Russell 2000 begins to show some strength and the Nasdaq finds a bottom I would rather not be long. Bull market corrections are normally short, sharp and scary and Friday could have been a one day wonder or a preview of things to come.
Remember, markets typically decline during the summer in midterm election years. May and June can be especially tricky with bottoms normally in the September-October timeframe. When coupled with a shrinking QE, slow economy and what some are calling an overvalued market we should be especially wary over the coming months.
The ECB floated a trial balloon last week over the possibility of a trillion euro QE program. With the euro rising and economic conditions not improving the ECB reverted to a tried and true tactic of leak and deny. The ECB immediately denied it was considering QE but the leak was already making the rounds. That allowed more than one ECB official to keep the rumor going by "officially" denying it. This is like telling a person not to think about an elephant. It is impossible to do because your first thought is an elephant. If the ECB officials tell the press "We don't know anything about a 1T euro QE program" it immediately propagates the rumor.
The U.S. warned Russia it would face more sanctions if it followed through with a barter deal with Iran. Russia let it be known that it would be just as willing to barter for oil, use gold as a payment or even accept payment in regional currencies as to use the U.S. dollar. Oops!
That triggered a flurry of angry responses from the U.S. but they were more than likely meaningless. The Voice of Russia warned that "Russia is preparing to attack the Petrodollar" in response to the sanctions placed on Russia. The existence of Petrodollars, that means oil is traded in dollars around the world, is a pillar of America's economic strength because it maintains the value of the dollar as the global reserve currency. China and Russia would love to use the current sanctions squabble to launch the Petroruble and move all Russian exports away from the dollar.
This is a major deal for the U.S. because once the dollar starts to shrink as the reserve currency it could be a very long drop and it could literally cause a bigger crisis than the Great Recession in the USA. Unfortunately I doubt the current administration can do anything to stop it.
Since 1952 the U.S. economy has averaged a recession every 5.2 years. The Great Recession ended in Q2-2009 meaning we just entered the last quarter of the five year period after that recession. While there is no guarantee of a pending recession we are not exactly setting the world on fire with our economic growth. This has been the slowest recovery on record and the forecast for the next two years is basically flat. The BLS said this has been the slowest jobs recovery since 1939.
The current bull market is 1,278 days old. The 1987 crash came at 1,311 days into a bull market. That is yet another piece of worthless trivia. Marketwatch ran an article titled "Shut up already! It is not 1929." Chuck Jaffe said it was a "bull market for bearish forecasts." He is definitely right. I have never seen so many headlines proclaiming the end to be near.
As one analyst reported the capacity for stupidity is virtually unlimited. Venezuela president Maduro mandated that any properties leased for 20 years or longer will be sold to current tenants at government mandated prices within 60 days, essentially confiscating all long-term rental properties in Venezuela. The countdown began on March 28th. If property owners refuse to sell their property the government will assess them a penalty of 29,000 euros, which must be paid within 5 days. If it is not paid it will double to 60,000 euros. Note the government is requiring payment in euros not dollars or the worthless Venezuelan currency. Individuals and corporations have no rights in Venezuela.
Comstock Partners penned an article this week on the shaky foundation to the market. With consumer spending 68% of GDP, wages flat lining, unemployment still high after five years, food and energy prices rising, health care cost rising, etc, the outlook for the future is not positive. The Stock Market's Shaky Foundation
The chief economist at Saxo Bank, Steen Jakobsen, said on Thursday the S&P was only 10 points away from a 30% correction. He expects the S&P to peak around 1,900-1,950 and then collapse. He was not expecting it to happen instantly but more of a long slow meltdown starting soon and ending in Q4. He said the lack of earnings growth will be the cause. Over the last year companies have been manufacturing earnings growth by buying back huge amounts of stock. That can't last forever.
Analysts at Societe Generale predicted on Wednesday that the era of low volatility was drawing to a close based on their analysis of hedge fund activity.
The American Association of Individual Investors (AAII) said investor money invested in equities was again reaching highs dating back to 2007. The percentage of cash invested rose to 67.2% at the end of March. That is the third largest percentage since 2007 following 68.1% in September 2007 and 68.3% in December 2013. Markets always seem to crash when people are the most at risk.
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