Fear Has Arrived. What’s The Plan?

February 24, 2020|5:48pm

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Anyone thinking that the stock market would simply ignore the potential economic impact of the coronavirus pandemic is getting a wakeup call this morning. Instead of focusing on the bright side and the stimulus plans that have been bandied about in places like China, stocks are now in full-on price exploration mode – to the downside.

On Friday, stocks fell, but the coronavirus really wasn’t to blame. Although the outbreak is far from contained, investors faced a different sort of worry on Friday – punk data in the good ‘ol USofA. In short, it was the Markit Services Purchasing Manager Index causing trouble at the end of last week. While the Markit number is a “flash” reading and can vary widely from the official ISM readings, I think there are two key takeaways here.

First, we aren’t talking about the manufacturing sector. No, this is the services sector. You know, the sector that has been holding up nicely and accounts for something on the order of two-thirds of the U.S. economy. Next, with the reading coming in at 49.4, there can be no denying that activity in the services sector appears to have slowed, which if confirmed by other data, is a pretty big surprise. It is also worth noting that this was the weakest print since 2013 and more importantly, was below the all-important 50 level (recall that readings below 50 indicate contraction). Also, the number was well below the 53.4 that economists were expecting. As one analyst put it, “A collective “yikes” filtered through markets: Treasury yields fell, oil priced slumped, the price of gold rose, and stocks fell.”

Frankly, I took Friday’s report in stride. Sure, I raised an eyebrow at the number. However, this report also runs contrary to almost all other data relating to the U.S. consumer. Thus, I didn’t see it as a reason to panic.

Then came the 2:00am alert on my phone saying that Dow futures were down first 700, and then 900 points. This certainly got my attention and puts the current pullback in a different light.

I’ll opine that there is clearly high-speed trading involved this morning. And hedging. And shorting for profit. And taking profits. And running for the hills. It’s clearly a one-way street today and there is simply no telling where the indices end the day. If I had to guess, I’d bet that the Dow will fall more than 1,000 points at some point in the day. Remember, computers run wild on days like these and don’t stop until the closine bell rings.

From my seat, the first key question we have to consider with the S&P down over 100 points is, how much of this is “real” and how much should be seen as trading “noise?” How much is fundamental and how much is traders all doing the same thing at the same time?

To be sure, we’ve seen this movie before. Something causes a bad-news panic to begin in an overbought/over-believed market. The computers do their thing and a waterfall decline ensues. Within a few days/weeks, prices wind up going too far. Then, out of the blue – and usually when the outlook is the darkest – something good comes along (friendly Fedspeak for example). Next the V-bottom occurs. And within days, the indices are right back to where they started. Such is the way the game is played these days.

Unless, of course, there is something happening to cause the U.S. consumer to stop spending on a dime. In the early days after the Financial Crisis, traders learned the hard way that John Q. Public and his family will pull in the reins quickly if they get scared. And when the consumer stops spending, the U.S. economy slows down – fast.

So, for me, the question of the day is if this pandemic will scare consumers here in the U.S. I.E. scare them enough to put that vacation on hold. To avoid the mall (oops, I mean Amazon.com). To wait a while on upgrading those kitchen appliances. To scale down on their birthday gifts. Etc.

At this stage, I don’t see the big, bad, bear case evolving. And yes, it makes sense to add a “(yet???)” to the end of the last sentence. But from my perch, the bottom line is we don’t have thousands of cases of the coronavirus across the country. The virus isn’t killing people in the United States of America. As such, I’ll argue that the folks won’t stop using Microsoft. They won’t change their spending habits to any great degree. (Well, okay, I will agree that this might not be a great time to be a cruise ship operator!) And if the consumer doesn’t change their spending habits, then the U.S. economy isn’t likely to be severely impacted. And if the economy isn’t impacted to any great degree, then earnings will be fine. And if earnings are fine, then the market indices WILL recover in time. Especially if the central bankers of the world start talking nice again.

For now, it is important to recognize that this is the dip that investors were worried wouldn’t ever give them a chance to “get in” a few weeks back. This is the dip that should be scaled into. This is the dip that Warren Buffett said he will be buying.

However, it probably isn’t a great idea to do all your dip-buying at once. No, take your time. Spread it out. Give yourself a chance to take advantage of the sale going on in some of the big names. Next, recognize that you won’t get the bottom – you rarely, if ever, do. But adding to positions and/or portfolios during a big scare has been a great strategy for a very long time. And frankly, I don’t think this time will be any different.

Weekly Market Model Review

Each week we do a disciplined, deep dive into our key market indicators and models. The overall goal of this exercise is to (a) remove emotion from the investment process, (b) stay “in tune” with the primary market cycles, and (c) remain cognizant of the risk/reward environment.

The Major Market Models

We start with six of our favorite long-term market models. These models are designed to help determine the “state” of the overall market.

There are two changes to report on the Primary Cycle board this week. First, the Leading Indicators flip-flopped again this week; moving back into neutral territory (albeit the reading is “high neutral”) from positive. In addition, the Risk/Reward model also pulled back to the neutral zone. The good news is that there are no sell signals on the board at the present time. But, given that 4 models now sport neutral readings, I think we have to recognize that the environment “could” be shifting. I’m not ready to declare that a change is afoot. But I will admit that my favorite big-picture models are starting to wobble a bit. The bottom line is (a) pullbacks never “feel” good when they are happening but we also need to recognize that a “dip” may be unfolding and (b) I still believe we are in a “buy the dip” environment.


* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability – NOT INDIVIDUAL INVESTMENT ADVICE.
View My Favorite Market Models Online

The State of the Fundamental Backdrop

Next, we review the market’s fundamental factors in the areas of interest rates, the economy, inflation, and valuations.

There was a change to take note of on the Fundamental Factors board this week. Our Inflation model upticked to positive and flashed a fresh buy signal. While one can argue that deflationary pressures remain in place and are problematic from a central banker point of view, it is important to remember that low inflation environments have historically been kind to stock market investors. So, with the Fundamental board in good shape, I’ll continue to opine that the bulls should be given the benefit of any/all doubt and all the dips (scary and otherwise) should be bought.


* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability – NOT INDIVIDUAL INVESTMENT ADVICE.
View Fundamental Indicator Board Online

The State of the Trend

After looking at the big-picture models and the fundamental backdrop, I like to look at the state of the trend. This board of indicators is designed to tell us about the overall technical health of the current trend.

The key change to the Price Trend board is the pullback by both our Short-Term Trend and Channel Breakout System models. The Trend model moved from positive to neutral as the major indices are now off their highs and have made no price progress over the last two weeks. And the Channel Breakout System, which is the most skittish of our trend-following indicators moved to a sell lasts week. However, it is important to note that it wouldn’t take much upside action to flip this indicator back to positive. Bottom line is that the trend is starting to look a bit shaky from a near-term perspective but still in good shape from the intermediate- and longer-term trend perspectives.


NOT INDIVIDUAL INVESTMENT ADVICE.
View Trend Indicator Board Online

The State of Internal Momentum

Next, we analyze the “oomph” behind the current trend via our group of market momentum indicators/models.

The was a fair amount of movement on the Momentum board again this week as the Short-Term Trend and Breadth model slipped back to neutral and all three of our “Thrust” indicators moved from positive to neutral. While this is hardly a death knell for the market, it does indicate that the momentum tailwinds that have been in place for some time appear to be fading a bit here.


* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability – NOT INDIVIDUAL INVESTMENT ADVICE.
View Momentum Indicator Board Online

Early Warning Signals

Once we have identified the current environment, the state of the trend, and the degree of momentum behind the move, we then review the potential for a counter-trend move to begin. This batch of indicators is designed to suggest when the table is set for the trend to “go the other way.”

The Early Warning board continued to move toward the bears side of the ledger last week. However, given that price has already started to slip and that pullbacks have been short and shallow of late, I’m not interested in pounding the table with a bearish argument here. Sure, the news flow wasn’t great and many of the leaders took a hit last week . However, the bottom line is the moves in many of the big-name winners was getting out of hand and the bulls were due to take a break.


* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability – NOT INDIVIDUAL INVESTMENT ADVICE.
View Early Warning Indicator Board Online

Thought For The Day:

An investment in knowledge pays the best interest. – Benjamin Franklin

All the best,
David D. Moenning
Investment Strategist

David D. Moenning

Disclosures

At the time of publication, Mr. Moenning and/or Redwood Wealth Management, LLC held long positions in the following securities mentioned: MSFT, AMZN

Note that positions may change at any time.

NOT INVESTMENT ADVICE. The opinions and forecasts expressed herein are those of Mr. David Moenning and Redwood Wealth and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as investment recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

Mr. Moenning and Redwood Wealth may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.

The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

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