Market Overview

Stocks Seem to be Searching for Equilibrium Amid Fears of a Coronavirus Resurgence

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Stocks Seem to be Searching for Equilibrium Amid Fears of a Coronavirus Resurgence

(Friday Market Open) They say the end of the week is time to unwind. But this week traders and investors may be taking some worries home with them for a couple of days.

After Thursday's big selloff, the market looks like it's regaining at least some ground, but with the Cboe Volatility Index (VIX) in the upper 30s after closing above 40 yesterday, market participants seem to still be on edge about the sustainability of the economic reopening amid fears of the coronavirus resurgence.

Thursday's selloff—the biggest one-day decline since March—seemed to be the unwinding of positions that had built up amid weeks of optimism. However, this morning's advance in index futures suggests Thursday's route might have gotten a little overdone. Would that be re-winding?

It's tough to say at this point. During the heady days of the pandemic, Fridays seemed to come with a hair-trigger, with investors seeming to want to pare back risk into the weekend. Might today mark a return to those days? Early signs point upward.

Can the Bounce Hold?
Investors may want to watch for whether the market can hold the gains into the weekend. It wouldn't be a good sign if the market ended flat or lower, and that might raise questions about a W shaped stock market recovery taking shape instead of one that looks more like a V.

Still, it can be argued that yesterday's selloff was a healthy thing given how much stocks have gained in the rebound since the coronavirus-sparked decline. One encouraging sign was that after dipping just below the 3000 marks yesterday, the S&P 500 Index closed above that psychologically important round number.

The return of volatility should serve as a reminder of what many investors have known all along. No market—bull, bear, or sideways—moves in a straight line. The COVID-19 pandemic has been a game-changer for sure. But the policy responses—fiscal and monetary—helped to right the ship, at least in the short term. Longer-term, there's plenty to be optimistic about, but for now, it's probably best to look at Thursday's pullback as a reminder that markets sometimes overreact to the downside as well as the upside.

Thursday Switch to Risk-Off: Crude, Rates, Volatility
Sometimes the risk-meter operates on a dimmer switch, easing gently from confidence to caution. Thursday it was definitely more of a toggle switch—a broad-based selloff that left no stone unturned. Defensive sectors—Utilities and Staples—were the so-called leaders, falling "only" 4%. Energy and Financials took the hardest hit, falling more than 8% and 9%, respectively. Crude oil—often seen as a harbinger of stronger or weaker economic activity—took it on the chin, dropping 9% after flirting with 40 earlier this week (see more below).

Financials were sharply in the red Thursday after enjoying a nice three-week rally, in part a reflection of the interest rate outlook. A mere few days ago we were talking about the 10-year Treasury yield doing better, and now it's collapsing back below 0.7% after flirting with 0.9% last week. Falling yields often reflect economic uncertainty as investors flock to bonds and other areas of the market sometimes seen as "safe havens," though no investment is truly safe. Banks can be especially vulnerable to lower yields because that often has a direct negative impact on net interest margin—the spread between the rates on what they earn (auto and home loans, for example) and what they pay on deposits and interest-bearing accounts.

The problem with weak Financials is that it often makes it hard for other sectors. While it's true that some recent rallies have been able to advance without much help from the banks, historically it's a hard push. Financials have their fingerprints on every sector, and weakness in the Financial world generally can reflect weakness elsewhere, too.

Rounding out the risk metrics, volatility is back, in a big way. The market's fear gauge—the VIX rose a cool 48% Thursday to settle above 40 for the first time since April 23. While yesterday's spike puts the VIX to only half the 80+ level it touched in March, it's a good bit above the mid-20s from earlier in the week, and substantially higher than the mid-teens, where the VIX spent much of last year.

But Friday Begins with a Partial Turnaround
One positive sign heading into Friday's session is the partial turnaround in some of the hardest-hit sectors. Cruise lines and airlines are gaining ground in the early going, with Carnival Cruise Lines (NYSE: CCL), Norwegian Cruise Lines (NYSE: NCLH), United Airlines (NASDAQ: UAL) and American Airlines (NASDAQ: AAL) all up 10% ahead of the open. These were among the hardest hit yesterday, so perhaps it's good to see there's still buying interest on the dips.

Banks, too, look to be reversing some of yesterday's losses, with the big banks up between 3% and 5% ahead of the bell, helped in part by some early strength in the 10-year yield. And despite crude oil's (/CL) relatively muted rally this morning, the Energy sector has regained some lost ground.

The big question heading into the weekend is whether this latest shift to caution puts us back into the spring pattern, where the market pared back risk at the end of the week, and led to a string of Friday down-days.

screen_shot_2020-06-12_at_9.50.48_am_1.png
CHART OF THE DAY: HOW FAR MIGHT THE PULLBACK GO? Yesterday's selloff was a big one with the S&P 500 Index (SPX–candlestick) dropping almost 6% and closing near its lows. This took the index below its 21-day exponential moving average (blue line) but left it above the 50-day (purple line). If the market takes another leg down, we could see SPX move closer to its next support level at the 61.8% Fibonacci level. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Technically Speaking: Correction in the Cards. The S&P 500 Index (SPX) was sort of consolidating around the 3200 levels early this week, which may have been an indication the bullish SPX rally could start unwinding, to some extent. We got a taste of it yesterday with SPX down around 7% from the 3233 it reached on Monday. Now that the broader index has been correcting, where could we see the next potential support level?

SPX closed below its 20-day exponential moving average (see chart above) so the next support level could be the 61.8% Fibonacci retracement level, which would take the index to around 2934. And if that level coincides with the 50-day simple moving average that could end up being a strong support level for SPX. But overall, the uptrend is likely still in play unless we see a fall below that 2934 level. It's really a matter of how well those levels hold in the pullback.

The Fleeting Crude Rally: Yesterday's market selloff wasn't too kind to crude oil prices, which fell over 9%. That's the most it's fallen since April when crude prices went as low as $6.50 per barrel. This could be a result of the overall market selloff but also rising inventories—the Energy Information Administration (EIA) data released yesterday showed another record build-up of crude—which tends to throw the supply and demand equilibrium off balance. Sure, there may have been an increase in demand as the economy started opening up but it looks like it's not been enough to reduce all that extra supply. And with uncertainty about the second wave of COVID-19 cases, investors might be becoming nervous and likely selling off some Energy holdings.

Rounding off the bad news on crude, the recent announcement by OPEC+ members on a production cut agreement added little more than a temporary sugar-high, as CNBC reported a number of member states falling behind on their production cut commitments. It goes back to the old adage: The cure for high prices is high prices.

5k, 10k, and Marathon: Investors of a certain age remember where they were in March of 2000, when the Nasdaq Composite (COMP) blew through 5000 to the upside, then immediately to the downside. That 5k number stayed in the rearview mirror for 15 years before it was finally eclipsed. If it hadn't been such an epic movie, with 5000 such a big round number, it might not have received as much attention in retrospect. But as it stood, we traders couldn't help but think about that unfortunate investor, trader, or money manager who top-ticked the COMP back then.

Fast forward to this week, where COMP blew through 10000 and made a quick reversal. Though it's tempting to draw parallels—as some market watchers and commentators have been doing—the fundamentals driving big tech these days are far different than those driving the dot-coms from the turn-of-the-century. Granted, the COVID pandemic represents something new, but so does the breadth and magnitude of the response from policymakers. In the end, 5000 and 10000 are just numbers on a board—reflecting the fundamentals of the companies in the index. And investing isn't a sprint, or a 5k, or even a 10k. It's a marathon.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

 

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