If something doesn’t feel quite right about this past week’s weakness, you’re not crazy. The 4.6% loss the suffered by the SPDR S&P 500 Trust ETF (SPY) last week looks almost comically overdone. In fact, it was the worst showing since March, though just for the record, that March drubbing actually set up a nice rebound move. On the other hand, as rough as last week was – and as rough as the past two months have been – it doesn’t really feel like a true bottom has been made.
Amazingly enough, both scenarios are exactly what they feel like they are.Stocks are stupidly oversold and ripe for a bounce, but last week was anything but a bottom-making capitulation. Throw in the fact that we finally saw that much-feared ‘death cross’ for SPY, and traders are even less certain of the true state of the market.
It’s time like these most investors wish they had another hobby, or at least more distractions.
Yes, the market will eventually recover, even if this is a prelude to a bear market. Most people truly believe that. Even if it’s not the beginning of a bear market though, a marketwide malaise is starting to set in. That’s weighing in on stocks, right or wrong.
The one thing that’s been largely missing from the panicked discussions to date is perspective. Here’s at least a small dose of that, via a look at the one biggest thing working in favor of bullishness right now, and the one big thing working against it.
Perspective
I mentioned this to Well-Rounded Investor subscribers a few days ago, but it merits repeating. In short, this round of selling is unusual in that it doesn’t appear rooted in true trouble or doubt for stocks. Rather, it almost appears to be the result of investors desperately trying to convince themselves that all is not well. They’ll use any excuse to drive stocks lower, but in the absence of a good reason, they’ll come up with a bad one. Preferably, they’ll pluck a reason from headlines as a means of connecting the mental dots.
Yes, the trade/tariff war is a concern. It’s not a new concern though.
Stocks soared on Monday and Tuesday when it looked like President Trump and China’s President Xi Jinping looked like they were going to come to amicable terms on trade. When that message was walked back to merely the previous status quo on Wednesday, however, traders treated it as if it was a new development.
It wasn’t.
Neither was the threat of inflation. Neither is the likelihood of more rate hikes intended to quell that inflation. Investors are acting, but they don’t appear to fully believe the reasons they’re acting. This is the market trying to shake out all the chickens, but without actually stepping over the edge of the cliff itself.
One particular data nuggets leads me to that conclusion, and though it’s good news on the surface, it’s actually bad news in the grand scheme of things.
Bad News: There’s a Lack of Genuine Fear
The short version of a long story: Major market bottoms are made when fear and hysteria are at their highest levels. Oddly enough, last week’s crash didn’t incite soaring levels of fear. Friday’s close of $263.66 for SPY was the lowest close it’s made since May, but the S&P 500’s Volatility Index (VIX) – a pretty good fear gauge – failed to even rival its peak levels seen in October when stocks first started to implode.
SPDR S&P 500 Trust ETF (SPY) vs. Volatility Index (VIX)
It’s not just the VIX pointing out the odd lack of concern on the part of traders, however. The put/call ratio says the same thing. That is, in light of the harrowing selloff from last week, traders aren’t buying nearly as many bearish put options as you’d expect them to. They were buying far more in October when that pullback could have been chalked up to mere temporary weakness.
SPDR S&P 500 Trust ETF (SPY) vs. CBOE Put/Call Ratio
There’s a superficial interpretation of this data that actually leads to a bullish conclusion. That is, if traders aren’t really bearish despite market weakness, it’s only a matter of time before that optimism gets re-priced back into the market. That’s not the way the market’s sentiment ebb and flow works, however. Far more often than not, major bottoms are made when investors are terrified. We just don’t have that capitulation yet. Ideally, it would look a lot like what we saw in February and March.
That doesn’t mean the market won’t bounce out of last week’s beat-down this week. It may well happen. It’s simply to say any such move may not be long-lived, putting us right back into a similar situation within a matter of weeks… if not days.
Good News: There’s a Lack of Bearish Volume
Just so there’s no confusion, let me be clear – there was above average volume behind the selling seen over the course of the last three days of last week. But, given the scope of the selloff and the chance we’re on the verge of a major correction (if not a full-blown bear market), one would have expected to see more. Investors are still mostly hesitant to let go of stocks, even if they’re saying otherwise.
S&P 500, with Daily Volume Data
Then there’s the X-factor… the so-called death cross, where the SPYders’ 50-day moving average line crossed below its 200-day moving average line, portending doom for the broad market. I’m surprised the event didn’t get more media coverage.
On the off-chance you’re unfamiliar with the premise, a 50-day moving average line’s move below a 200-day moving average is supposed to be a clue that a downtrend has become irresistibly bearish. The track record for that assumption, however, is more than a little spotty. There is some truth to the idea, but there’s not enough truth to the idea to trade it blindly.
Simply put, death crosses that take shape during a true bear market and/or materialize during a true recession do indeed signal more bearishness ahead, whether that be for the market or a particular stock. But, that’s as it should be. On the other hand, death crosses that occur during a bull market or in the midst of economic growth usually pan out to be solid buying opportunities.
The graphic below tells the tale. All the death crosses for the S&P 500 are marked with a yellow dot. Recessions are highlighted in blue. The S&P 500’s earnings are plotted at the bottom. (Warning: It’s a big image, and will likely take up your whole screen.)
S&P 500, with 50-day and 200-day Moving Average Lines
You decide for yourself what this particular death cross means. Given the earnings growth and GDP growth we’re seeing though – even if it’s slowing down – I’m leaning towards this death cross being a buying opportunity.
Bottom Line
That’s certainly not the prevailing opinion right now. And, to be completely honest, should SPY slide under last week’s low of around $262.40, investors may well throw common sense out the window and bail out of stocks just because. Though the S&P 500 is only priced at 17.5 times its trailing earnings, and 15.6 times its forward-looking earnings (that’s as cheap at the market’s been in years), if enough traders don’t believe the projected earnings are in the cards, then they’ll punish the market. They may even cause the very recession they fear.
I’m a bull here, however, even with a less-than-perfect economic backdrop.
I’m not a blind bull though. I like the fact that there’s not a lot of selling volume right now, even when there arguably should be. I don’t like the fact that we’ve yet to go through a blowout, capitulatory plunge. We’re stuck in the middle in the meantime, which can be maddening for investors who don't mind holding on through the occasional turbulence.
It’s entirely possible a bounce early this week could drive a recovery through all of December and into January. Perhaps that’s when we’ll finally get that overdue blowout selloff. Truth be told though, at this point I’m actually hoping we get it this week.
At least we know what to look for as a marker of capitulation, and we also know the likelihood of an actual recession is quite low. Let’s not make more of this weakness than we should. Proper perspective says we're due for a garden variety correction, but nobody's making it easy for the market to cleanly dish it out.
