By C. Jonathan Camarda
CMT®, CPWA®, CFP®, ChFC®, CLU®, CFS®, BCM®
The weakness in China is being spotlighted as a big reason for the recent tumult in global markets. Further deceleration in the China factory output fell to its lowest level since 2009, and that set the selling “tornado” on August 21st. The concern is the global economy is weak. A bright spot is the whispers that this may cause the Fed to “tap the brakes” on a September rate hike. The non-silver lining to this is that that cause—a global weakness—may not assuage investors to “buy” at this juncture, which is a double-edged sword. This recent global sell off may offset the recent strong domestic employment numbers. Stay tuned as the Fed “turns”.
The worrisome detail, lately, is how the mega cap stocks are falling hard—adding to the broader market bleeding. Moreover, given these bigger names (think Apple or Exxon) are widely held stocks in most managed portfolios, and this has given some institutional investors a feeling of when the “other shoe may drop”. In addition to this, Oil has been the proverbial “elephant in the room”, for a while. We saw it actually dip below $40 a barrel before last week’s rally to $48 currently. This could be just an oversold bounce. If it is, and the fact that bullish option activity only goes out to mid-September suggests, there may be more pain ahead. This compounds the slowing global economy story. This seems to go beyond the mere supply/demand dynamic and contributing to the global economic halt. This has been a main ingredient in the market meltdown.
It is worth mentioning that it has been a few years since we had a market free fall (last August and October were back-to-back corrections in a few month span). The past few years, we had huge bail outs and QE to treat the “patient”, which, of course, camouflaged the issues since the Lehman debacle in 2008. Again, it’s important that markets do go down. The rock and a hard place part of this is that the Fed has very little pliability with rates near zero if a new crisis does, in fact, occur. Let’s get back to markets moving down. Corrections (10%) and “bear market runs” (20%) are healthy for the market cycle. However, this has been counterintuitive the past few years as the Fed with its policy has thrown the veritable kitchen sink at any sign of a downturn. This correction has the “smell” of a normal pause in a multi-year “running of the bulls”. The Fed will be convening in mid-September, so it has a lot of work to do to hash through these conflicting signals it has been facing. The question is: how could it entertain a rate hike with the backdrop of global shocks on a seemingly daily basis? This is one that will be intriguing to follow. The Jackson Hole meeting points to an “on principle” raise in 2015—will it be September or December?
Finally, let’s take a look where markets are in reference to recent low/support levels. First, we will look at the S&P 500 on its two-year chart, and you will see we have tested the aforementioned October 2014 lows. As you can see, it didn’t broach its October lows. After last week’s bounce, it will be intriguing to see if we build a bottom or retest and broach last year’s lows.
However, the same cannot be said about the Dow Jones Industrials, which is heavily weighted by those mega caps talked about earlier. Early last week actually broached its October 2014 lows, but closed right at those levels. For those of you who think institutions don’t play “chess” with these technical levels, take a look at that “line drive” highlighted in blue. The next step is to see if we now move lower or gather strength. It has since bounced off those lows, but the new trend is down. Will it find this a bottom or retest those lows of last year and potentially broach them? Too early to call that “shot”.
Meanwhile, small caps/Russell 2000 have held up nicely above its October 2014 lows, and has had the most resilient bounce off last week’s “Black Monday-Part Two”—well, it was actually more “grey”, but we will see how it trends from here after damage done on the penultimate day of August.
A final indicator I watch during times like these is the put-to-call ratio (again, puts are shorts on stocks and calls are longs; thus, when put-to-call ratio gets high, it indicates bearishness), which becomes a contrary indicator that leads to market reversals. We are reaching levels on the equity put/call ration we haven’t seen in a few years—perhaps displaying oversold conditions.