What's Up With This Crazy Stock Market?

Includes: DIA, SPY
by: Leo Kolivakis

Jeff Macke of Yahoo Finance reports, "What's making the stock market act so crazy?":

It’s not your imagination: the stock market has gone a little bonkers lately. This week alone the Dow Jones Industrial Average plummeted 272 points on Tuesday, rocketed back 274 points Wednesday and sank more than 330 points today. October has already recorded five days where stocks moved more than 1%. That’s as many 1% moves as we saw in the prior five months combined.

So why are stocks so crazy? ... It’s October. I know it sounds crazy but October is almost by tradition the most volatile month of the year.

Global concerns... The world is always crazy but right now things seem to be rockier than normal. Government officials in Europe are arguing over the best way to ward off an impending recession, growth is slowing to a relative crawl in China and Japan is tipping into a recession...

Bad news outbreak... It’s not just overseas. The Ebola outbreak has some investors worried that the U.S. economy, which hasn’t been great to begin with, could freeze. Despite good headline data on employment many economists point out that wage growth in the U.S. has been almost non-existent... So what should you do? Probably nothing.... Professional traders would love to see you panic into dumping some quality blue chips. Don’t be that person.

Macke also discusses technicals, stating two key levels for the S&P 500 he's looking at:

Wednesday and Thursday marked the biggest one day rally and worst one day drop for the Dow Jones Industrial Average for all of 2014. That’s the first time those extremes have been hit on back to back days in nearly 17 years....

So where do we go from here? As most of you know, when markets get emotional I turn to the technicals... With the Dow poised to erase its yearly gains, it can be viewed as a good wash-out catalyst but grown ups, or at least professional traders use the S&P 500 for their charts. The next big line of support is the 200-day moving average at 1,904. Look for traders to start trying longs if and when we get there but frankly, I’m not so sure it holds.

If 1,904 fails stocks I have air pocket risk down to 1,800 on the S&P. That’s another 6.6% lower from where we closed yesterday. If we get there the S&P 500 will be negative for the year and the VIX will be at least 40, depending on how fast the drop comes... 1,800 is your Maginot line. If stocks fall below that the war is over and the Bears won.

There are plenty of opportunities out there but be careful, some industries have already crashed hard and you won't see a rebound anytime soon. Check out the one year chart of coal and iron ore shares. Stocks like Alpha Natural Resources (ANR), Walter Energy (WLT), Peabody (BTU), and Cliff Resources (CLF). They have all been obliterated thus far in 2014 and some of them risk heading the way of Patriot Coal, ie. bankruptcy (a slowdown in China and low natural gas prices accelerated the death of King Coal in 2014).

And with the mighty greenback surging to new highs, it's hammering commodity, energy (XLE) and gold shares (GLD) as commodity and oil prices keep sinking lower. Fears of the euro deflation crisisspreading to the rest of the world are also weighing on commodity and energy shares. As I recently discussed, things are a bit better in Greece but that country remains at the epicenter of the euro crisis and there are risks of political turmoil ahead there which could erupt into another full blown euro crisis.

Now, with mighty Germany starting to buckle, it will be interesting to see if the ECB stops jawboning and starts acting forcefully with massive quantitative easing to help address the serious threat of deflation in the euro zone. As I recently stated in my comment on the soaring USD, my fear is that it's already too late and that the ECB has fallen way behind the deflation curve. This is another reason why you're seeing global equities getting pummeled and U.S. bonds continuing to rally with the yield on the 10-year Treasury bond now standing at a 16-month low of 2.3% (and heading lower).

As far as the U.S. stock market, keep an eye on cyclical leaders like semiconductors. Shares of Micron Technologies (MU), Intel (INTC), and Texas Instruments (TXN) had a great run this year but seem to be rolling over. It will be interesting to see if they consolidate and move higher or head much lower. Also worth noting that homebuilders (XHB) are at a new 52-week low, which is worrisome.

The big declines that have caught my attention lately are in oil drilling stocks like Ensco (ESV), Noble (NE), and Transocean (RIG). Carl Icahn has taken a bath on that last one and these are great examples of why high dividend stocks are not as safe as they seem. They are all offering very attractive dividends and they keep sinking lower. I worry about a lot of big oil stocks, including the majors, and don't think they will be able to maintain their dividends as the price of crude has fallen to $85 a barrel and is heading back to $60 or lower as global deflation takes hold (read my comment from last December on time to short Canada).

Despite the October selloff, I'm not worried of another stock market crash. I maintain that the real risk in stocks remains a melt-up, not a meltdown, but you have to pick your spots carefully or risk getting slaughtered (as discussed above, look at coal, gold, commodity stocks that were obliterated in 2014). This is why a lot of active managers underperforming this market will continue to do so as we head into year-end. There are a lot of things that could derail this endless rally but there is still plenty of liquidity to drive all risk assets much, much higher.

But fears of a euro deflation crisis, an Ebola pandemic, and plain old October jitters are hitting stocks hard. In this environment dominated by high-frequency robots, traders seem to sell first and ask questions later. Panic selling can lead to overreaction on the downside but I warn all of you, this isn't the beginning of the Big Crash all the bears have been warning you about. With inflation pressures non existent, decent earnings, continued share buybacks and massive financial liquidity can all propel stocks much higher in a flash.

And those of you long volatility are doing fine thus far in October but if the ECB starts cranking up its QE, watch out, volatiliy will crash back down to multi-year lows. I'd be very careful here betting on a major crash, thinking the VIX will explode up to 40 or 60.

Finally, I continue to favor social media stocks like Twitter (TWTR), small caps (IWM), technology (QQQ) and biotech shares (IBB), including smaller biotechs (XBI) that have sold off lately. These are extremely volatile and risky but there is a great secular story here that will play out for many years to come. Keep an eye on companies likeIdera Pharmaceuticals (IDRA), Biocryst Pharmaceuticals (BCRX), Progenics Pharmaceuticals (PGNX), Synergy Pharmaceuticals (SGYP), Threshold Pharmaceuticals (THLD), TG Therapeutics (TGTX), XOMA Corp (XOMA). I would take advantage of the latest selloff to add to some of these biotechs.

But it's October so people are nervous. Many investors are worried as they watch wild gyrations in the stock market on a daily basis. Get used to it folks, with interest rates at historic lows, record inflows into hedge funds, and high-frequency traders having a field day, this is a glimpse of what is to come. There will be violent corrections but I'm not in the crash camp, at least not yet.

Disclosure: None