Good Morning. In case you haven't noticed, I've recently made a modest adjustment to the label I place on the current market environment. In short, I've switched my view of the current market from being a "sloppy period/consolidation phase" to a "corrective phase."
What's the difference, you ask? While the change may appear to be quite subtle, the key is that during what I call a "sloppy/consolidation phase," one should give the bulls the benefit of any/all doubt and buy the dips aggressively. The thinking is that in this type of market environment, stocks basically "kill time" in order to digest the recent gains. Thus, during a sloppy period, the downside is generally limited and the assumption is that stocks will likely return to an upward trend at some point in the not-too distant future.
However, during a "corrective phase," doubt definitely begins to creep into the picture. Instead of expecting to see a "garden variety" pullback of 2% to 3% and making the assumption that the bulls will eventually prevail, one has to be on alert for things to deteriorate (oftentimes quickly). In other words, during a "corrective phase," we need to expand our view of the downside potential. Remember, risk happens fast in this algo-driven world we now live in and one can't just assume that an oversold market will automatically rebound.
Exhibit A in my argument here would be the big dive stocks took in the summer of 2011 as well as the dances to the downside that occurred in 2012. If you will recall, in 2011, the market dove 19% in something like 9 days. The key is that once the algos and the fast-money locks on to a theme, they tend to stick with that theme until something changes. And it is for this reason that the trends in the market have tended to be one-way affairs since 2010.
So, will the current decline keep going? Will the forced liquidations courtesy of the dramatic dives seen in gold, bonds, and emerging markets continue? Will the big funds/institutions that can somehow utilize the zero-interest cash being made available by central banks these days stop putting that capital into the U.S. stock market? And will the sophisticated "carry" trades (sell short the yen and invest the proceeds in stocks) that have been all the rage this year in the hedge fund community continue to blow up?
Obviously, I don't have an answer to any of the questions posed above. And I do recognize that stocks are now oversold and likely due for a bounce. I see the gaping hole on the chart of the S&P and understand that gaps like this one tend to get filled sooner rather than later. I also see that the move in the bond market has gotten more than a little overdone (and if you don't believe me, take a peek at the chart of the TLT ETF). And speaking of overdone, that is probably the word best used to describe the destruction seen recently in the commodities (take a look at the weekly charts of: GLD, SLV, and JJC) and emerging markets (again, check out the weeklies of EEM, EEB, EWZ, and EPI).
But my point on this fine Monday morning is oftentimes a trend in motion tends to stay in motion and that markets can stay irrational longer than a trader hoping for a bounce can stay solvent. Therefore, we must be willing to stay flexible and recognize that what is happening in the various markets is not exactly "normal."
Remember, stocks and bonds aren't supposed to move in the same direction. And the basic concept of diversification is that certain asset classes aren't supposed to be correlated. But the one thing we've learned since 2008 is that sometimes correlations all go to 1.0 - and when that happens, all bets are off in terms of what is traditionally works.
I guess what I'm trying to say is that, like most everyone else, I expect to see a bounce in stocks, bonds, gold and the emerging markets. It is probably a good bet that something will come along very soon that will cause the algos to go the other way (and in a hurry) in all of these markets. Therefore, we should probably expect the volatility to remain elevated for some time yet.
However, I think we should also recognize that after the requisite bounce, the true trend of these markets may reveal itself. So, is the spike in bond yields from 1.63% to 2.514% over or will rates continue to rise - albeit at a slower rate? Will the worries over global growth continue to plague the world stock markets? And will the reality that the bottom of the QE punch bowl is becoming visible continue to cause major shifts in trading strategies?
Again, I can't be sure of the answers and as I wrote last week, none of us "know" anything for sure about the future. It is for this reason (well, that and the current readings of my market models) that I've made a shift in my outlook for the overall market environment, subtle as it may be. In sum, I think it is time "to be careful out there." And while I could be wrong, I think we need to recognize that anything can happen in this game and that making assumptions about the next move could easily prove problematic for those using a crystal ball.
Turning to This Morning ...
The Shanghai Composite had its worst day in almost four years as Chinese stocks dove -5.3% overnight. The plunge was tied to comments from the PBOC which suggested monetary policy isn't likely to change (note that expectations had been building in the markets that a rate cut from the Chinese central bank would be forthcoming). In addition, Goldman Sachs cut its 2013 growth outlook for China to 7.5% from 7.8%. Coupled with an ongoing rise in interest rates (the yield on the U.S. 10-year is trading at 2.638% this morning) and the bottom line is there is a sea of red in the global stock markets and U.S. futures at this time.
Here are the Pre-Market indicators we review each morning before the opening bell ...
Major Foreign Markets:
- Shanghai: -5.31%
- Hong Kong: -2.22%
- Japan: -1.22%
- Germany: -1.56%
- France: -2.19%
- Italy: -1.97%
- Spain: -2.24%
- London: -1.38%
Crude Oil Futures: -$0.07 to $93.62
Gold: -$8.60 to $1283.40
Dollar: lower against the yen, higher versus euro and pound
10-Year Bond Yield: Currently trading at 2.638%
Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -16.13
- Dow Jones Industrial Average: -134
- NASDAQ Composite: -25.04
Thought For The Day ... "Not everything that counts can be counted, and not everything that can be counted, counts." -Albert Einstein
Positions in stocks mentioned: none