Stock Market Dispenses Another Warning Shot

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 |  Includes: AMZN, BBH, DIA, IWM, NFLX, PCLN, QQQ, SPY
by: Acting Man

Friday's Odd Action

The stock market has spent much of this year trying to exceed its year end 2013 high, and finally succeeded in terms of several indexes in late February/early March. However, it has also dispensed a number of warning shots along the way. On Friday, another such warning shot arrived. A number of momentum stocks were whacked quite badly on Friday, but interestingly, many have actually begun to decline about two weeks ago already.

Friday left the market with a not very pretty daily candle, but what is probably most noteworthy about the action is that it happened on tremendous trading volume. Partly this can probably be ascribed to the expiration, but it is still a bit of an exclamation point considering the many divergences we have been able to observe recently.

Below are a few charts that illustrate the situation. First a look at the Nasdaq and various momentum issues that have been favorites of speculators for some time and have begun to founder a bit.

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Nasdaq, 5 minute chart. It gapped up at the open on Friday and immediately started selling off.

Next a look at a few daily charts of several momentum stocks that show that the weakness actually started already in early March. Underneath continued strength in the overall market, many leading stocks have begun to deteriorate. Mind, this is not a comment on whether these particular stocks are overvalued (they most probably are) or on their business (which is probably good). We are merely interested in technical conditions here, and have picked the individual stocks almost at random. We could have made this a much longer list.

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Priceline (NASDAQ:PCLN), daily – one of the strongest momentum stocks until early March, but it has been declining since then, even though the NDX almost recaptured its early March high last week.

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Netlflix (NASDAQ:NFLX) daily, another momentum favorite. Its price action was quite similar, also peaking in early March. Friday's accelerated sell-off looks a bit worrisome to our eye.

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BBH, the biotech ETF. Up until recently, the Rydex biotech sector fund held the by far biggest share of bullish Rydex assets (more than 35% at the peak). BBH mainly represents biotech big caps such as Gilead (NASDAQ:GILD), Biogen (NASDAQ:BIIB), Amgen (NASDAQ:AMGN), Celgene (NASDAQ:CELG), etc. – it peaked in late February already and had a very bad hair day on Friday.

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Amazon (NASDAQ:AMZN) daily – this stock peaked shortly before its late January earnings report and has diverged from the NDX as well as other momentum stocks since then.

Russian Sanctions Are Bad for Business

Although the Nasdaq was weakening right from the gap-up opening tick, the broader market attempted an intraday recovery on Friday, which appeared to be cut short when news came over the wires that president Obama had imposed sanctions on Bank Rossiya, a small Russian bank thought to be used by people "close to Putin". This is bad for business, no matter what one thinks of Mr. Putin and his policies. It is also a legally quite dubious move, as Mish correctly points out. It is as though a court were punishing Bob for what John has done, since obviously, Bank Rossiya neither "invaded" the Crimea, nor did it organize the referendum there (we are putting "invaded" into quote marks, because Russia didn't really invade either. Its soldiers were already stationed on the Crimea, quite officially. They did of course spread out from their base, so it's obviously not a clear-cut case).

In the Western media there is a tendency to report on the sanctions hitting various Russian oligarchs as if they were solely bad news for said oligarchs. Apparently no-one has really thought through yet that if they withdraw their capital, it will also be bad news for all those places where that capital is now invested.

This is one reason why we are saying this move is bad for business, no matter what one's views on the political backdrop are. To the extent that sanctions are hitting average Russians (and reports indicate that quite a number of average Russians found that their credit cards would suddenly no longer work in the West), they only help to strengthen Mr. Putin politically at home, while punishing even more people who had nothing to do with the events. Alas, "we" must not "lose face", so we are eagerly shooting ourselves in the foot.

Moreover, anyone au fait with history should be aware that these tensions vastly increase long term political risk. Most Russians see things in a completely different light from the picture presented in the Western media. Don't be misled by the fact that our media like to quote Putin's political opponents a lot – they enjoy no broad political support, in fact they are a small minority. The media in Russia also report on events in a lopsided manner of course, and partly the views of the average Russian are influenced by that fact (don't forget though that the Russians are people who were for many decades quite cynical about their press).

We are pretty sure that Mr. Putin isn't itching for a fight with NATO (actually, Russia remains in the "NATO partnership for peace"), but who knows how a future leader might think about this possibility in 20 years time? There is also a tendency to underestimate the country's military prowess, but it no longer has an army relying on shoddy Soviet equipment (funny enough, that rag-tag army was consistently overestimated by the West way back when), not to mention that it continues to be the world's second-largest nuclear power. Why did the West think it necessary to blunder into Kiev and take a hand in events there? Russians see it as the West dabbling in things that are none of its business. Sanctions only confirm to many the picture of the West as an enemy rather than a partner, and we can be pretty sure that the average Russian also believes that Russia has the right to pursue an independent foreign policy.

Let us get back though to the business aspect. Let's assume that it is true that Russia will fall into recession, as is argued here. How is that going to be good for the global economy? It seems more likely it will affect all of Russia's major trading partners as well (hello EU!). The US economy is one of the least directly affected economic regions, but it will be affected indirectly. Global economic interdependence is after all higher than ever, and aside from Russia we also have a marked weakening of China's economy to consider. The times when it didn't matter what happened in these economies are long past.

Here is a look at the SPX:

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SPX, 5 minute candles. On Friday it attempted to regain its opening high, but then deteriorated rather quickly. Perhaps it was only a coincidence that the sanctions-related news broke around that time, but it may not be.

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The daily chart shows a reversal candle on extremely high volume. Volume often surges on expiration, but this is still quite an outlier.

It is also remarkable that the DJIA has not confirmed the other indexes this year. Per experience, this is actually more important than one would think. The DJIA is not cap weighted (instead it is price weighted) and only harbors 30 stocks. Why should it matter what it does? We don't know, we only know that it has mattered on a number of previous occasions. Especially memorable in this context were the divergences between DJIA and SPX/Nasdaq that occurred in the year 2000. We also remember that the signal was widely dismissed as "meaningless" at the time. A memorable positive divergence occurred at the 2002/2003 lows.

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The DJIA has not confirmed the other indexes this year.

And lastly, a chart that was recently published by sentimentrader. It shows the Citi "Economic Surprise" index compared to the SPX. Interestingly, the economic surprise index seems to lead the stock market instead of the other way around. Readers may recall that we have frequently mentioned on previous occasions that the stock market has essentially lost its "discounting function" since around 1998. Since then, it has more often been a coincident or lagging rather than a leading economic indicator.

A further note on this: in a "normal" interest rate environment, the yield curve tends to invert prior to market peaks and economic downturns. This phenomenon can however no longer be observed in a structurally sufficiently damaged economy in which the central bank is holding short term rates close to zero. Japan has experienced several cyclical downturns since 1989 that were not preceded by yield curve inversions.

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The Citi economic surprise index and stocks – a lead-lag function different from what one would normally expect.

Conclusion:

More smoke signals are emerging that suggest all is perhaps not as well as it appears on the surface. At some point they will matter, and one should be mentally prepared for that eventuality.

Charts by: Stockcharts, Sentimentrader