Not the Red Sox, The SOX!

October 11, 2018

It’s hard to fathom the thought of being grateful for a day in the capital markets like the one we had yesterday. But, in fact, the markets can’t go up forever with next-to-no volatility. It’s simply unhealthy.

When we started the day yesterday there weren’t any news stories causing alarm; which leads me to believe that decline was more a result of programed selling than anything else. Recall, investors will often have “limit” orders floating in cyberspace that will only be triggered if and when a certain price (up or down) is reached. I believe that once the selling began it triggered limits at lower and lower prices. The cascade ensued driving the markets back to roughly where they were in mid-July. I know it’s distressing when you turn on the television and see 3% + declines in the major averages; however, I encourage you to keep this in context. This is simply a retracement of three months, not the end of the world.

For the S&P 500 breath was terribly negative with 17 advancing issues and 488 declining issues. At the same time volume was 41% greater than its average over the last 30 days which signifies that investors were running for the exits in large numbers. There was similar action on the NASDAQ yesterday.

All 11 sectors finish the day lower. Technology was the worst performing sector, down 4.77% and Utilities, often thought to be somewhat of a safe-haven, finished 0.53% in the red. There were five sectors finishing more than 3% in the red; they were communications, consumer discretionary, energy, industrials and financials.

The bad news about yesterday’s price action is that we did not see a rally in to the end of the day. In fact, we closed near the low levels of the day. That increases the chance that we could see some continued selling pressure today. Overnight the futures were indicating the Dow could open this morning 225 points lower but as I write this at 8:52 in the morning the futures are only suggesting a decline of 76 points at the open. A lot can change between now and 9:30!

Looking forward…

We cannot ignore the technical data. Some damage has been done to the charts and will require us to keep a very close eye on this going forward. US stocks had their worst day since February 8 with a decline of roughly 3.29%. The S&P broke below its 50 day moving average (DMA) and sits within about 1% of its 200 DMA price. This is a technically important indicator and if it were to be violated on the downside we may need to rethink our short-term approach.

The SOX index…. for all of you Boston fans, no, this is not the Red Sox who beat my beloved Yankees this week and will now face the Astros for a shot at the American League title. This is the Semi-conductors Index (SOX). The SOX is often thought of as a leading indicator for the broad market. It has made a clear break below support in the last week. This is worth watching as it could predict future price movements more so than the 200 DMA on the S&P 500.

Tomorrow, Friday, marks the beginning of earnings season. We are not expecting much damage to earnings from tariffs this quarter; In fact, we expect earnings to be quite good. For reference we expect S&P earnings this year of roughly $160 and $177 next year.

Treasury yields have been on the rise with the 10 year yield now sitting at 3.16%. Recall, when yields rise, prices fall. Pundits will often claim that rising treasury yields are a negative for stocks because investors find the now-higher-paying bonds a better alternative and may abandon their stock shares.

Joe Monaco from Monaco capital had an interesting take on this situation. Joe recently said he is convinced the jump in interest rates is due to the Chinese selling vast amounts of US treasuries. By selling them they, 1) push prices down and interest rates higher, which hurts the US consumer and possibly President Trump‘s approval rating right before an election, 2) they get billions of US dollars, allowing them to make open market purchases of their currency, the renminbi, which supports its value in international markets, and 3) with all those renminbi they can now freely spend inside the country of China to stimulate their own economy. Joe goes on to say that if he is right that at the end of this cycle when the treasury selling subsides that we will be in for one heck of a rally in the US financial markets.

As of right now we still think these dips require patience and can even be used for buying if one has the cash to put to work. Recall the old comment from Warren Buffett “be fearful when others are greedy and be greedy when others are fearful.”

We will continue to keep an eye on both the fundamentals and technicals. We will report to you as we see material developments.