Perspective Time: Market Still In Trading Range After Its Worst Day Of 2019

After a day like today, many investors might feel the urge to flee for the hills. What’s important, however, is to keep things in perspective. 

Sometimes these are one-day events, and we’ll find out tomorrow if that’s the case. However, a quick bounce back would probably raise the chances of ultimately revisiting today’s lows, so it might be healthier for the market if this plays out over a few days and people can start taking a broader view and determining stock market winners and losers. One idea might be to let it play out for a bit and watch what happens, without making any sudden moves from a position of fear.

All things considered, it’s been a pretty good year for stocks, but the market hates uncertainty and that’s the primary overhang as people contemplate the trade picture with China. We’re not used to seeing the sausage get made right in front of us. What used to be hidden behind closed doors is now done right out in the open, and it may not be pretty at times. This is one of those times.

Those without a lot of market experience tend to go all in or all out at times like these, but veteran investors often go part-way in and part-way out. While cutting back one’s exposure to stocks can sometimes be a fine thing to do, it also helps to have a plan, know your ultimate goals, and let some time pass before making big decisions after a day like Monday.

For those surveying Monday’s carnage and wondering if there are reasons to stay in the market, it might be worth considering a few things:

While the steep losses to start the week definitely looked dramatic, let’s not get carried away with fear. We’ve talked for a long time about the market being in a range, and we’re still in it. The range looks to extend roughly from 2800 to 3000 for the S&P 500 Index (SPX), and there appears to be a lot of support at 2800.

If you look at the action late in the day Monday, the SPX didn’t really test the 2800 level. It managed to claw back a bit. So that might remain a point to watch as the week continues. The 200-day moving average of 2790 isn’t far below 2800, so that also might represent a potential support point. The SPX has managed to come back several times in the last year after descending below its 200-day. See figure 1 below.
Even an SPX at 2800 would still be down only 7% from the recent all-time high, and, as we noted earlier this summer, stocks were arguably priced for perfection at above 3000.

Last week’s new tariffs on China were a punch that no one probably expected, but if there’s one thing investors have learned over the past few years, it’s to expect the unexpected. These aren’t markets for people who can’t get used to a little volatility.

Volatility was elevated today, but not out of this world. The Cboe Volatility Index (CBOE) reached levels above 24, but we’ve been at these levels in the last year and volatility ended up retreating. An elevated VIX can make for exciting markets if you’re a short-term trader, but anyone in it for the long-term might want to keep things in context and not watch all the daily ups and downs, because a lot of that is simply noise.

All that said, it looks like some investors might be changing their portfolios to build in more of a cautious outlook. 

What’s interesting about the fixed-income buying is it that it was mostly shorter-term, with maturities of six months or less. That could be a sign that many retail investors want to put their money back into stocks, just not at the prices where stocks were trading up near recent highs.

Cyclicals Battered as “Flight to Safety” Mentality Takes Hold

Looking at stock performance on Monday (if you can bear to), the so-called "cyclical" sectors including Technology, Financials, Energy, Communication Services and Industrials all got hammered, but Utilities, Health Care and Materials outperformed the rest of the market. That is, if you can really use the word “outperform” to describe drops of worse than 2% for some of those sectors.

Also, gold, the Japanese yen, and VIX all rallied, and bonds continued to climb. Sometimes these instruments are seen as key risk barometers, and tend to rise when the market gets cautious.

The 10-year yield (which descends as the underlying Treasury note climbs), finished Monday at just above 1.73%. Thats nearly a three-year low and isn’t too far from the long-term trough below 1.4% carved in the summer of 2016, back when Brexit fears first surfaced. Speaking of which, that could be another factor hurting markets right now, with the next Brexit flashpoint coming down the line Oct. 31.

All this “flight to safety”—as if any investment is safe, which isn’t the case—is pretty much what the market normally does when geopolitics flash red. In that sense, things are happening the way they’re arguably supposed to. 

Overall, it doesn’t look like investors are really spooked, and it’s worth noting that some buying interest did appear in the last 40 minutes of Monday’s session, allowing the major indices to close above their intraday lows. It’s anyone’s guess, of course, if any of that momentum can carry over into Tuesday.

Semiconductors and Apple Inc AAPL, which have huge exposure to China, fell dramatically, probably to the surprise of few. Financials took a beating thanks in part to the sharp drop in Treasury yields, where the 10-year yield is now well under the S&P 500 dividend yield. That could be something that’s steering some investors into the defensive parts of the market like Utilities.

Energy got clobbered even though crude prices didn’t fall nearly as much as stocks. Crude might have gotten propped up by recent sharp drops in U.S. stockpiles and more tension in the Persian Gulf over the weekend.

As the week moves on, stuff to watch for is any sign of renewed investor interest in more of the cyclicals and any potential revival, however small, in the 10-year yield. Both would be important signs of optimism. 

A continued standoff in the trade war would probably prevent stocks from retesting recent highs anytime soon, and people might be less eager to pile back in on any good news. There’s likely be some muscle memory as people consider what happened the last time there was good news on the trade front, which was after the G20 summit in June. That rally, which took the market to new highs on hopes of a trade thaw, is the one being taken apart now amid new tariffs and as investors express concern over China allowing its currency to fall.

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