The first low is rarely the ultimate low when we get "new-news".
The market has seen some wild swings in the last week…and the recent bounce in the stock market has been quite impressive. However, we need to keep things in perspective. Experience tells us that whenever we get a sharp decline that is caused by some negative “new-news”, the “first low” is almost never the “ultimate low” we see in reaction to this new-news. Instead, the initial decline is usually followed by a sharp rally that helps to work-off the very-short-term oversold condition that results from that initial drop…BUT this “pop” is usually followed by another decline that takes the stock market down to lower-lows.
This is exactly what we saw in May. When the “new-news” (that the trade negotiations had broken down) caused the market to slide 5%, it was followed by a sharp bounce that retraced 1/2 to 2/3 of the initial decline. (The 1/2 to 1/3 retracement depended on whether you measured the move on closing basis or intraday basis.) However, this was then followed by another leg lower to meaningfully lower-lows.
The same thing took place in October last year. The “new-news” from Chairman Powell that short-term interest rates were “nowhere near neutral” caused the stock market to drop about 9%. This was again followed by a 1/2 to 2/3 retracement of its decline over a very short time frame…only to roll back over and make new lows (significant new lows).
The recent moves are VERY similar to the last two corrections
What we have seen this time around is eerily similar. A 6% decline in reaction to “new negative news” (of new tariffs)…was followed by a 1/2 to 2/3 retracement of the decline (as of last night’s close). This sharp bounce has worked-off some of the short-term oversold condition that existed at the beginning of the week…just like the “initial” sharp bounce did in the previous two examples. Will the stock market roll-over once again and take out those “initial lows” now that it has worked off some of its technical condition???
Today's "new-news" is still fresh...and has not changed
Yes, we believe that it will. On the fundamental side of things, the heightened tensions over trade with China will continue to keep global corporate executives to hold-back on capital spending plans. This, in turn, will not help earnings growth for the rest of this year (and into 2020). The earnings picture was already a problem. Despite all sorts of hoopla surrounding the positive earnings reports and guidance from some high profile names, earnings guidance actually fell for the 3rd and 4th quarters of this year during the month of July. They didn’t fall a lot, but this took place BEFORE President Trump upped the anti on tariffs, so those who are looking for a nice pick-up in earnings growth in the second half of the year are going to be disappointed.
There were more signs of weakness before the new tariffs were announced
Other indicators are also showing signs of further slowing of global growth. The 2yr/10yr Treasury yield spread fell to below 10 basis points yesterday...it’s lowest (flattest) condition since 2007. We’d also note that the CRB Commodity Index is testing an important support level. The 170 level was the low for this index in 2017 and at the late December lows of last year. It is also the bottom line of a “descending triangle” pattern. Therefore, any break below that level will be another indication of lower demand and slower growth. It could/should also bring back concerns about deflation. (A move below that 170 level on the CRB will still leave it above its early 2016 lows…which were reached at the end of the oil market crash of 2015…but it would still be a negative development on a technical basis).
We’d also highlight that one of the most important commodities in the world…copper…is also testing a very important support level. “Dr. Copper” broke below its trend-line from the early 2016 lows this week…and also tested its 2018/2019 lows. Like the CRB, copper has also formed a “descending triangle” pattern. Therefore, if “the Doctor” breaks below those lows (of $255) in any meaningful way, it’s going to be quite bearish for this key commodity…and it won’t be good for growth or deflation concerns either.
To review, we have a situation where something has changed. President Trump has announced new tariffs that will go into effect at the end of this month. The fundamental situation was already slowing, so this will create more headwinds. Technically,we’ve seen a short-term bounce off of the very-short-term oversold condition, but the “new news” that caused the initial decline has not changed at all. Therefore, we believe it is very likely that we’ll see a replay of the “down/up/down” (to a lower-low) move we’ve seen the last two times the stock market has reacted negatively to important “new news”.
The smart money is still betting on a further decline
We’d also note that the open interest on the VIX call options we’ve been highlighted for a couple of weeks remains quite high. On the one hand, this means that the street dealers are probably still short those calls…which will cause a sharp rally IF (repeat, IF)the market rallies or even holds steady. HOWEVER, we have to remember that the small number of investors who bought those calls (and bought the puts on the IWM & HYG) “knew something”.
Speaking of "smart money," Bezos sold almost $3bn of AMZN stock recently
In other words, they are the smart money. Therefore, there is no guarantee that the stock market will calm down or rise further going forward. If it rolls back over (like it has after a quick short-covering rally in the past), the smart money is going to do quite well…and the “dealers” in the street are going to feel some more pain once again………….BTW, speaking of the “smart money,” Jeff Bezos recently sold almost $3bn worth of Amazon stock between July 29th and August 2nd.