Bear in the Woods: Buyers Might Still Be Hard to Find Coming Back From Holiday

There’s an old saying in trading circles: “Don’t try to catch a falling knife.” After a string of bruising losses— with the major stock indices down nearly 15% since the start of the month—it seemed market participants were all waiting for others to be the first to stick their hands out. The wait for the bounce extended into the overnight hours Christmas night, but in the early morning hours Wednesday, a bounce seemed to have commenced.

But as we’ve seen in recent months, unsustainable rallies are often the norm. The question on many minds today may be, will this be the one to take hold? After another crushing blow in Monday’s shortened session, stocks entered the holiday in bear market territory, generally defined as a loss of 20% from highs. The speed of this drop is what’s really amazing. In just 10 calendar days, the SPX has fallen about 250 points, or close to 10%. Monday was the worst Christmas Eve session ever.

With Monday’s 2.7% losses factored in, the S&P 500 Index (SPX) is down nearly 15% so far in December. The Nasdaq Composite (COMP) already entered a bear market of its own—down more than 20% from its high—late last week. The Russell 2000 (RUT) small-cap index hit bear territory earlier this month. 

Where’s the Buying Interest?

More and more investors appear to be closing the door on 2018—exiting their positions and waiting for the new year and hope of better tidings. As those investors pull up stakes, there’s just not much buying interest below. That might be a big part of why markets keep diving day after day—the proverbial falling knife. Though Wednesday begins with a bounce, there still seems to be a dearth of buying interest. 

Monday’s selling might have been exacerbated by worries out of Washington after media reports that Treasury Secretary Steven Mnuchin had called some of the biggest U.S. banks over the weekend to discuss their liquidity. Mnuchin followed that up by stating that banks are healthy and the economy continues to function smoothly, but his calls might have raised more questions than they answered. Although Mnuchin’s intentions were good, they may be bringing up more questions about financial stability and whether there’s an issue we all didn’t know about. For seasoned traders and  investors, the calls may have been reminiscent of similar calls made during the heady days of the 2008-09 financial crisis.

Some of that uncertainty could be getting reflected in market volatility. The VIX “fear gauge” ticked above 36 on Monday and down a touch Wednesday morning to below 35, but still near the highest level since February and way above historic norms. There’s just a lot of concern about geopolitics, the U.S. and world economies, and the free-fall in crude oil. Crude popped back a bit Wednesday to near $43 a barrel, still near 18-month lows.

This elevated volatility could help put any rally into question, simply because it indicates a high level of fear among investors. If VIX starts to sink a little, that could help maintain today’s early positive tone. If VIX stays elevated or climbs from where it is, it might be a sign that the rally can’t last.

Risk Avoidance Seems to Be a Theme

All this could be generating more of a “risk-off” trade, as 10-year Treasury yields fell to eight-month lows below 2.75% by early Wednesday. However, the “yield curve” measuring the gap between 2-year and 10-year yields did widen a bit early this week to around 16 basis points. It had fallen below 10 last week, and some analysts believe an inverted yield curve can be a recession signal. So far, the curve hasn’t inverted.

It’s hard to believe, but when December started, stocks were still up for the year. By the end of Monday’s shortened session, the S&P 500 Index (SPX) was down more than 11% since the end of 2017 as uncertainty continued to wreak havoc. This has been the worst month for the stock market since the Great Depression.

One interesting take-away from the Monday’s action is that Treasury prices rose (with yields falling) even as the S&P 500 utilities sector took a dive. This suggests that many investors are looking for possible safety rather than opportunity (though no investment can ever be truly “safe”). People have been buying bonds rather than bond substitutes like utilities, and that may mean they want potential bond market protection.

No Hiding For Any Sector

There’s not apparently much investor interest in other stock market sectors, either, judging from Monday’s action. As the session ground along, every sector was down 1% or more, with utilities leading the way with a 4% plunge. Other sectors also sometimes considered “defensive,” including staples and real estate, were also among the worst performers. 

Meanwhile, the recent decline in crude oil prices sent the U.S. benchmark WTI down more than 40% since its peak in October. Some question whether crude is driving stocks lower or vice-versa, and the answer is “yes.” Meaning yes to both. It looks like both are engaged in a negative feedback loop, with lower crude prices apparently unnerving some investors about global economic health, and the resulting drop in stock prices putting more pressure on crude. Oversupply is another issue that continues to help push crude prices lower. WTI flirted with $42 a barrel Monday, the lowest it’s been since the summer of 2017.

These are tumultuous times, and the thin volume around this time of year might be exacerbating moves, so investors might want to take extra care when they come back today. The question becomes, when will buyers show up? 

Blue Chip Pounding and a Flight to Safety? The Dow Jones Industrial Average ($DJI - candlestick chart) led all the major indices lower ahead of the Christmas holiday, falling over 650 points. Meanwhile, the yield on the 10-year Treasury (TNX - purple line) fell over 4 basis points to below 2.75% in an apparent flight to the perceived safety of U.S. Treasuries. Data sources: S&P Dow Jones Indices, Cboe Global Markets.Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

A Tendency is Not a Certainty: OK; so Santa delivered a lump of coal in this year's stocking. Should this call into question the idea of a Santa Claus Rally, a January Effect, or any other seasonal tendency? Not necessarily. It's important to remember that long-term averages are comprised of a wide variation of individual data points. Besides, the classic definition of the Santa Claus Rally is a measure of returns between Christmas and the end of the first week in January. The recent market meltdown has significantly lowered the base from which the end-of-year rally starts. The 12-month trailing P/E now stands at 17 (down from 25 a year ago), a level many see as oversold considering recent earnings growth (see below). So, despite this being a December to forget, a classic Santa rally is still possible. However, investors who bought stocks over the past few weeks, in anticipation of a jolly holiday return, have likely not fared too well.  

Earnings Still Seen Strong for Q4: For investors tired of hearing all the bad news and watching major indices get crushed almost every day, some good tidings potentially could come next month in the form of earnings data. While analysts’ average S&P 500 earnings per share estimates for Q4 have fallen over the last few weeks, six of the 11 S&P 500 sectors are expected to report double-digit earnings growth while four in 11 are expected to report double-digit revenue growth, according to Factset. The sectors that Factset sees reporting double-digit earnings growth are: Energy, industrials, financials, communication services, consumer discretionary, and health care. Another possible piece of good news: Factset pegs the S&P 500 Index’s (SPX) forward price-to-earnings ratio at 14.2 going into this week. That’s well below the five-year average of 16.4, and, for the first time in a while, also below the 10-year average.

Debt Clock Could Tick in 2019: At times like these, when many investors might be hoping for some kind of friendly tidings to hang their hat on, it may seem cold-hearted to point out something else that could go wrong. Still, the inability of Congress and the White House to reach a deal on the budget might not be a good sign ahead of next summer, when the divided government will have to once again find a way to raise the debt ceiling. Economists at Goldman Sachs, quoted by CNN, say they expect the debt ceiling deadline to come between August and October, and that debate around it could potentially be “more disruptive” than any debt ceiling debate since the 2011-2013 period. While summer is still a long way off, the debt might be another thing to consider putting on the worry list for next year. That’s not to say there will necessarily be a showdown, but it’s good to keep these things in mind and be prepared for possible fireworks.