foxex: Big Red Candles

Chart Advisor | Focus on the Price

Thursday, February 27, 2020

1. Stocks fall hard as yields hit historic low

2. Option and stock prices agree: it's bad

3. Why didn't Chinese stocks fall so far today?

Market Moves

Bond prices hit new all-time highs as yields hit historic lows. Stocks sold off heavily in the wake of fears concerning Coronavirus impact on consumer activity. The S&P 500 index (SPX) closed 4.5 percent lower and the Nasdaq 100 index (NDX) broke 5 percent declines leaving big red candles on charts everywhere. Selling continued right into the close.

Perhaps the biggest concern driving professional money managers, however, was that the 10-year Treasury Note index (TNX) fell so precipitously. Some analysts suggested this may translate into the Fed lowering rates (instead of their plan to keep rates stable all year). Such an event would signal potential recessionary forces, so it is no surprise why selling accelerated throughout the session today.

Option and Stock Prices Agree: It's Bad

When stocks fall in drastic market selling, chart aficionados know it is useful to pay close attention to the Volatility Index (VIX) and how its price action compares with the S&P 500 index (SPX). The chart below shows four times in the past two months where the VIX and State Street's S&P 500 Index ETF (SPY) were at subtle variance. In each of these moments (marked by red arrows) the VIX priced in a higher degree of risk than was implied by the price action on SPY.

At the close of trading today, however, both the SPY and the VIX closed at extremes, showing a congruence between price action and risk pricing. That could imply that stocks are not predicted to continue falling much more. This sets the stage for a reversal in the next few days ahead, at such a time when the VIX may not rise as far as SPY prices fall. This would signal that investor fear may begin to disperse.

Traders Are Likely to Buy Tech Stocks on Market Weakness

Get Ready for the Big Bounce

SPONSORED BY SMARTASSET
Financial Advisor Mistakes to Avoid
Choosing a financial advisor is a major decision that can determine your financial trajectory for years to come. SmartAsset offers tips on common mistakes to avoid.
Learn More »

Why Didn't Chinese Stocks Fall So Far Today?

If stocks are falling because investors fear the Coronavirus might reduce demand and dent corporate earnings in the next quarterly reports, then wouldn't it make sense that the biggest stocks in the country with the most infectious cases (China) should have sold off the most today? Charts show that's not what happened as FXI fell by less than one percent. It's worth taking a moment to think about what happened instead.

The chart below compares the price action of the iShares China Large-Cap ETF (FXI), the iShares MSCI South Korea ETF (EWK) with the aforementioned S&P 500 index ETF (SPY). This action likely shows how the wave of fear concerning COVID-19 has moved from China, where prices seem to have found some support, to South Korea, where case numbers are climbing beyond expectation. The price action in these two ETFs could lay out a map for where the S&P might go.

Three possible scenarios for SPY (marked as A, B, and C on the chart), take their cue from the Asian index ETFs. Scenario A is the most bullish and assumes the S&P 500 will rebound similar to the Chinese index. Scenario B is less bullish and tracks what might happen if SPY follows the path of the South Korean index. Finally, scenario C depicts what will happen if COVID-19 cases start springing up in the U.S. in unexpectedly high numbers. Chart watchers can keep an eye out for opportunities based on these three scenarios.

The Bottom Line

Stocks sold off hard and left lots of red ink on the charts. The VIX seems to be in agreement, however, suggesting that the risk is fairly priced. This may imply a reversal soon. Bonds moved to new extremes creating a fear of recession ahead. Chinese and Korean stocks may provide a map for navigating the current market correction.