Home / Education
  • Correction or Something More?

    By Clint Sorenson, Chief Investment Officer for Sound Financial

    The market, as measured by the S&P 500 is now down YTD (SPY is down -1.10%) after being up more than 7.2% just a few weeks ago. The drawdown is nothing to panic about on the surface. Drawdowns over 10% are regular occurrences in the market. What is shocking, however, is how quickly this correction has occurred. In an overvalued market environment, risk can happen and it can happen fast. This is exactly what we are witnessing so far.

    In our note from yesterday (intended to address Friday’s market activity), we discussed that tops are typically processes that occur over multiple trading sessions. We displayed several market indices and measures of market internals, illustrating that the positive trends remained intact. Then yesterday happened. The Dow fell over 1600 points at the low of the day and finished the day down over 4%. In fact, during a ten-minute span the Dow fell over 1000 points. To the average bystander, this appeared to be complete insanity. 

    Market commentators were claiming that “something broke” on CNBC, looking for someone or something to blame. Quickly you saw reports of flash crashes and out of control “computerized traders” and “quant funds”. In my opinion, none of this was to blame. I think that the market broke a key technical level by breaching the 50-day moving average and this triggered the execution of a lot of stop-loss orders. The 50-day moving average is a commonly used, short-term trend indicator, the breach of which suggests further downside.

    Now the question is whether this will alter the intermediate and longer-term trends in the market. Yesterday was the first day during the sell-off where we saw a preference for safe-haven assets like Treasuries (The yield on the 10-year bond fell over 10bps). This means that investors were scrambling for liquidity and protection, something that often suggests that we are in the early innings of a much larger decline. The trends and market internals, however, are still positive over the intermediate and longer-term time frames. 

    I have included several charts for your review. As you will notice most of the market indices and measures of market internals are still firmly above their 200 day moving averages despite most falling below the shorter-term 50 day moving average yesterday. This implies that the long-term trend of the market is still positive despite the scary sell-off of the past few days. Furthermore, a common measure of overbought/oversold conditions, the NYSE McClellan Oscillator (click here for a description), is signaling the most oversold condition since 2011. This is useful in that it suggests that a short-term bounce may be in the cards, and that is where the true story will be told. If the bounce fails, I expect the market to test the longer-term 200 day moving average. If this subsequent test is accompanied by a widening in credit spreads and a flight to Treasuries, we may be in store for a much larger decline. Right now, this is just a much-needed correction. I will make sure to inform you if the longer-term indicators suggest taking a defensive stance.

    Chart 1: JNK/TLT
    The ratio of high yield bonds to long-term Treasuries remains in a risk-on posture despite the recent pullback in equities.

    Chart 2: NYSE Advance-Decline Line
    The correction has taken this common indicator of market internals to below the 100-day moving average. This is a key warning signal that more downside may be in store for equities. 

    Chart 3: S&P 500
    The correction has taken the S&P 500 down below the 50-day moving average changing the short-term trend of the index. However, the S&P 500 remains above both the 100 and 200 day moving averages suggesting that the long-term trend remains positive for now.

    Chart 4: Nasdaq 100
    The Nasdaq 100 remains above the longer term 100 and 200 day moving averages despite breaching the 50-day moving average yesterday. Therefore, the long-term trend remains positive for the technology heavy Nasdaq 100.

    Chart 5: NYMO - NYSE McClellan Oscillator
    The NYSE is now at the most oversold level since the August 2015 flash crash.

    Investment Advisory Services offered through Sound Financial Strategies Group, Inc. (“SFSG”), a Registered Investment Adviser. Certain representatives of SFSG are also Registered Representatives offering securities through APW Capital, Inc., Member FINRA/SIPC, 100 Enterprise Drive, Suite 504, Rockaway, NJ 07866 (800)637-3211. SFSG and APW Capital are separate and unrelated companies. 

    The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by APW Capital.

     Neither diversification nor asset allocation can ensure a profit or protect against a loss. Past performance is not indicative of future results. 


  • One Day Does Not Make a Trend

    In the last 25 years, according to CNBC, there have been 18 instances--including the decline on 2/2/2018-- where the Dow has dropped at least 500 points. Using Kensho Technology, CNBC analyzed what happened to the market after this type of decline. Typically, the Dow is up 2.83 percent one week after the drop and is positive 71 percent of the time. Of course, this may tell us nothing about what will happen next, but a drop of a little over 2% in the Dow is not that alarming.

    Valuations and market sentiment have been euphoric and the Fed is no longer accommodative. That leaves intermarket trends and the growth in the overall economy as the only positive factors supporting the rise in stock prices. A one day drop in the Dow does not change the trend. Tops are processes that are historically formed over multiple market sessions.

    Historically, long-term market tops are usually indicated by a deterioration in credit spreads and broad market internals (see the chart above). We illustrate the relationship between junk bonds and long-term Treasuries to show that risk preferences remain currently favorable. The cumulative advance-decline line of the NYSE (a dependable measure of market internal strength or weakness) also remains positive. Furthermore, the Dow and other market indices are still firmly above their 50, 100, and 200 day moving averages, which is suggestive of continued positive trends (see the chart above).

    We would not be surprised if the recent decline started a run-of-the-mill correction. Besides, it has been over two years since we have seen one. Usually, we get at least one 10 percent correction per year.

    A 2.5 percent decline is not a big deal. The trend is still up in most equity market indices and intermarket relationships still suggest a positive environment for risky assets. Furthermore, the economy is still accelerating upward suggesting this may simply be a flash in the pan. Until business cycle trends reverse to suggest taking a defensive posture, or trends in equities markets change, we maintain our positive outlook.

    Investment Advisory Services offered through Sound Financial Strategies Group, Inc. (“SFSG”), a Registered Investment Adviser. Certain representatives of SFSG are also Registered Representatives offering securities through APW Capital, Inc., Member FINRA/SIPC, 100 Enterprise Drive, Suite 504, Rockaway, NJ 07866 (800)637-3211. SFSG and APW Capital are separate and unrelated companies. 

    The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by APW Capital.

     

    Neither diversification nor asset allocation can ensure a profit or protect against a loss. Past performance is not indicative of future results.

     

RSS Feed
Powered by ID digital