foxex: That was Awkward

Chart Advisor | Focus on the Price

Tuesday, March 03, 2020

1. Bonds explode as stocks whipsaw over Fed announcement

2. What January actually indicated

3. Watching the market's acrobat

Market Moves

Fed chairman Jerome Powell executed an unusual tactic in an unusual way to bring investors some good news. It was met with selling. He announced the Fed's decision to cut the target for the Federal Funds rate by 50 basis points, and he waited until the market had been open thirty minutes to announce it. Making this unscheduled announcement of a surprisingly large rate cut should have made stocks jump higher. Why didn't it work?

There are three possible explanations, and the actual truth of the matter is probably found in some combination of these. First, the larger-than-usual rate cut actually wasn't a surprise to the financial community. The futures contract that predicts the Fed Funds rate had actually priced in the full rate cut as much as two trading days before it was announced.

Second, there remains a real chance that the impact of the COVID-19 virus is somehow going to be much worse than the spread of the virus itself. It's not that so many people will get sick or die, it's that they will get so scared they won't spend money on travel, entertainment and discretionary purchases. Whether this fear is well founded or not won't really be put to rest one way or another until late in April when a critical mass of earnings reports are released.

The third reason is a bit deeper. It may be that this market melodrama actually has very little to do with the Coronavirus scare. What if the current environment is nothing more than an opportunity for fund managers to take some profit from the last four years of great market performance and remove some of the risk in their overvalued portfolios?

If that were true, it wouldn't matter what the Fed announced, stocks would still sell off simply because there was that much money invested in stocks that needed to be redeployed into other areas such as bonds. If so, it would also help explain the chart below which displays the unprecedented and inversely correlated moves in bond prices and bond yields.

What January Actually Indicated

The chart below takes a backward look at the open and close for the the S&P 500 Index (SPX) during the month of January. A famous indicator known as the January Barometer quips, "as January goes, so goes the rest of the year." Well for 2020 that means that January actually forecast a downward move this year. The indicator's track record of prediction is 69 percent correct, and when it is wrong, anything more than a 5 percent move against the January low typically means lower prices to come. As of the current reading of the S&P 500 index we see that the market not only closed lower for January, more recently it fell below a four percent threshold. If it fails to regain that mark soon, history suggests there will be more selling to come.

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Watching the Market's Acrobat

When investors get overly optimistic, they tend to bid up their favorite stocks a bit too high. High-flying, acrobatic stocks that seem to defy gravity for a while often fall fatally to earth when the optimism unravels. The problem is that nobody knows how high of a price is too high for any given stock until after the fact.

However, the current circumstances make it very easy to recognize which stocks are fulfilling the role of this market's acrobats, that would be Tesla (TSLA) and Virgin Galactic (SPCE). Their meteoric rise may be followed by a drastic fall if, for some reason, market participants decided that the business prospects for these companies were a bit more unrealistic than previously calculated.

Were that to be the case, the chart below might help with early recognition of that event. This newsletter has twice before shown a version of the Wolfe wave analysis of TSLA shares. The recent bounce in share price shows that it was a worthwhile marker to consider. The red-dashed line represents a balance in the trend. If prices close below it then it becomes a recognition the previous prices were likely overdone. What will follow after that may not be pretty.

The Bottom Line

Stocks rebounded for only a brief moment after Fed Chairman Powell announced a 50-basis point rate cut to the Fed Funds rate. Three reasons might explain why, but they boil down to the fact that investors simply aren't ready to buy back in just yet. They seem to prefer bonds. How much selling will stocks do? Keep an eye on TSLA shares for a clue.