Stumbling Out Of The Gate: Q4 Weakness Continues In Broad-Based Selloff

Sometimes investors can find a sector to hide in when stocks take it on the chin. Not on Wednesday, as concerns about overseas economic weakness and trade wars ganged up on the market and took everything down with them.

Cyclical sectors that tend to fall in times of economic concern got slammed, but so did “defensive” sectors like Utilities and Consumer Staples as stocks suffered the worst day since late August. Small-caps are getting hit hard, and are within a few points of bear market territory. Only bonds and gold really got a lift Wednesday as it looks like caution is back in a big way.

Consumers Still Running the Show?

Until this week, healthy U.S. consumers appeared to keep the momentum flowing on Wall Street despite economic weakness in Europe and trade worries. The consumer has been carrying growth domestically, but with so much continued weak data elsewhere, there’s growing fear it could start to hit U.S. shoppers. That said, we haven’t seen anything yet pointing to a weakening U.S. consumer, only some hints that sentiment about the future might be coming down. We’d arguably need to see a slowdown in wage growth or a drop in retail sales (and not for just a single report) to verify any change in the consumer picture here.

While many analysts believe recession concerns are overblown, we could get more clues about U.S. consumer health in coming days. The payrolls report Friday might be paramount. If it shows wage growth declining, that could potentially lead people to believe economic problems are getting worse and send the market down again.

To keep things in perspective, this was only the second day of heavy selling, which is far from a trend. There’s nothing unusual about what’s happening, and major technical support levels didn’t get breached. All of this might offer some hope for later this week, especially as investors await key jobs data from the government on Friday. 

Heightened Economic Concerns Sparked by New Trade Fears

Growing economic worries, which got their initial spark on Tuesday from soft U.S. manufacturing data Tuesday, appeared to get worse Wednesday. That was partly due in part to a World Trade Organization (WTO) decision that raised fears of more trade tension between the U.S. and Europe even as the U.S. grapples over trade relations with China.

The U.S. plans to impose tariffs on $7.5 billion of E.U. imports after the WTO’s ruling, The Wall Street Journal reported late Wednesday. This added to trade trepidation and might have helped pressure the market after it posted some recovery from its lows earlier in the afternoon. By the closing bell, the Dow Jones Industrial Average ($DJI) was down 800 points in just two days. It’s a little like the quick descent we saw back in early August, which was also trade-related. 

Transports really put on the brakes, with some of the major airlines like United Airlines Holdings UAL and Delta Airlines DAL getting smacked around. Both fell more than 5% by late in the session. Auto manufacturers also had a bad day. On days like these, you’d almost expect to see weakness in more aggressive parts of the market like transports, Technology and Energy, but it was a bit surprising to see Utilities fall 1.25%, Health Care fall 1.5%, and Consumer Staples fall nearly 2%. Those are the places some investors tend to go when things get volatile.

Instead, it looks like people fled Wednesday away from equities and into bonds and gold. The U.S. 10-year Treasury yield fell back below 1.6%. For reference, it was briefly above 1.9% in mid-September. One point to potentially watch is 1.42%, which is around the three-year low that the 10-year yield posted back in early September. Some analysts think that barring a re-test of that, the market won’t necessarily fall out of bed.

Gold climbed 1% to back above $1,500 an ounce. That’s still a ways from the early September highs up around $1,560, which could be another level worth watching if you’re tracking investor sentiment.

Eyeing the Surface Cracks

The U.S. economy has chugged along, growing around 2% even while some other economies see slower growth and grapple with negative interest rates. Now there appear to be a few cracks on the surface, which we saw early this week with a round of weak data from the U.S. and overseas, along with political worries at home and geopolitical turmoil in Asia, the U.K., and the Middle East.

With October a historically volatile and sometimes difficult month, it seems pretty natural that some people might approach things with caution here and lighten the load a bit. What’s not really apparent yet is any major change in the pattern that would lead you to think it’s a repeat of Q4 2018 when things really went south.

Some people are making comparisons to the Q4 washout last year, but that’s not really all that valid. For one thing, rates are falling, not rising as they were then. Also, the market isn’t as reliant on the fortunes of just a few big companies like it was a year ago. The rally since January has been pretty widespread, with Technology a leader but also with participation from lots of other sectors. 

Some immediate cracks in the bullish thesis showed up with yesterday’s U.S. manufacturing data, auto U.K. construction PMI, and growth warnings from Germany’s leading institutes. Brexit jitters and China trade worries haven’t gone away either, but they’ve been out there all year and the SPX was up 20% in going into October.

As we noted earlier this week, October could have some bright spots despite the troubled start. Talks with China begin next week. Earnings season is getting close and could offer a welcome break from all the noise.

Getting Technical

Consider taking a breath and remembering the 2800 to 3000 range we’ve been talking about for the S&P 500 Index (SPX). We’re coming off the high end of that range and heading down, but unless the SPX takes out lows near the 200-day moving average—which is around 2837 as of Wednesday—you could argue we’re still not technically in really bearish territory. A test of that level or a drop below it for a day or two might change sentiment on the Street in a major way.

That said, there’s nothing wrong with being cautious or even taking some profit if you feel your exposure to stocks is higher than you originally planned. Where people might go wrong is by making seat-of-the-pants trading decisions based on fear instead of their long-term goals. The SPX fell to 2350 last December, and anyone who got nervous and sold then might be regretting it now. Sure, there’s no rule that says the SPX can’t fall back to that point. Even so, if you believe earnings can start to recover in coming quarters and we don’t face any signs of an immediate recession, that might be a tough argument to make.

The Cboe Volatility Index (VIX) ran up some gains Tuesday and Wednesday to back above 20 for the first time since early August. Still, it’s stayed below the August highs so far. That might bear watching, especially if it goes above 22 or 23. A move like that could potentially signal more concern and possibly more market turbulence ahead, because that’s pretty much where things topped out in August.

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