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Five Reasons And, What's Next?

Summary

When stocks make an outsized move, I become obsessed with the reasons why.

I think there were five excuses for Tuesday's dance to the downside.

The key going forward will be.

I've long believed that when stocks make a large move in either direction, there is usually a reason. A trigger. Or a driver to the action. And identifying the reasons behind the move has long been an obsession of mine. In other words, if the market makes a big move, I've got to know why.

I was out of the office for the better part of the afternoon yesterday making a presentation to advisors about an algorithmic strategy selection program developed by my colleagues and I at Numetrix Capital. The presentation went well as I once again got up on my soap box and stressed the importance of utilizing a modern approach to investment strategy selection and portfolio design to about 50 financial advisors.

I bring up my afternoon activities because I was not at my desk watching the carnage in the stock market all day long. As such, I was able to think about the action from a somewhat fresh perspective.

In speaking with one of my colleagues about the market picture, we came up with a theory about yesterday's dance to the downside. In short, we decided that the decline was likely attributed to five things.

First, and perhaps most importantly, the bottom line is it was time for a pullback. The market had "gone parabolic" over the past month and had become extremely extended in the process. Therefore, the table had been set for the bears to come out of hibernation, even if only for a few days.

Next, there was the issue of uncertainty. And anybody who has been at this game for any length of time knows that the market hates uncertainty. More specifically, I'm talking about the uncertainty over some near-term stuff including the SOTU (which Trump would show up?), Janet Yellen's last Fed meeting (would Yellen use this opportunity to position the Fed for a more hawkish stance going forward?), and the earnings from tech's heavyweights (will Apple (NASDAQ: AAPL), Alphabet (NASDAQ: GOOGL) et al deliver?).

As we discussed yesterday morning, interest rates are also part of the reason traders decided to hit the sell button early and often on Tuesday. The key here is that rates and inflation expectations are rising and some fear that the higher rates will (A) begin to take a bite out of the corporate profits that everyone on the planet is busy adjusting higher and (B) become modest competition for stocks, thereby dampening future demand.

So far, the excuses for traders doing some selling - all at the same time, of course - are pretty obvious. However, the next two reasons are a little more interesting.

Blame It On The Alligators

So... next up, I think we can, "blame it on the alligators." I don't recall who first began referring to institutional asset allocators as "alligators" but it has stuck with me.

I also can't take credit for this idea as Mr. Jeff Pietsch of Eastsound Capital Advisors was the one responsible for suggesting yesterday's dance to the downside was prompted by institutional rebalancing moves.

Jeff opined that last year's unexpected and outsized move in stocks caused asset allocations at big pension funds to get out of whack. Since most of these mega-managers must keep their allocations within set guidelines, Jeff suggests that the managers needed had to rebalance back to their stated targets during the first quarter of this year. And with the S&P up 7% or so near the end of January as of yesterday morning, there was no time like the present for the "alligators" to start the rebalancing process.

And T+2

And finally, there is something called "T+2"." This is industry lingo for the time it takes for trades made in a portfolio to "settle" and show up on a portfolio manager's books by the end of a reporting period. So, if you are a manager that wanted to be able to state in your month-end report that the stock market had become overextended and you decided to take a little off the table, yesterday was the day for you to pull the trigger on the trades.

So there you have it. The table was set nicely for some downside volatility to return and for the fast-money masters of the universe to take some profits. The question now, of course, is if the two-day decline will wind up being the latest in a very long string of buying opportunities or the beginning of a more meaningful pullback. Be sure to stay tuned, I think the action over the next 3 days will be VERY telling.

So far this morning, stock futures are rebounding on the "tone" of the SOTU, ADP's beat on private sector jobs data (234K vs. 180K), Eurozone CPI, German unemployment, and earnings. From my seat, the key will be to see if (A) traders use the early strength to sell into or (B) the dip buyers return en masse.

Thought For The Day:

If you don't do it this year, you'll just be one year older when you do. -Warren Miller

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research
Serving Financial Advisors since 1989
Serving individual investors since 1980
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Disclosure: At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None

Note that positions may change at any time.


Disclosures

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

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The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

Disclosure: I am/we are long GOOGL.