The Message From The Market This Morning

March 26, 2020|3:51pm

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Market analysts love to talk about “the action” that occurs in the markets. Many, including yours truly, believe that the manner in which the market moves – especially after important news – can provide a “message” about the current environment. To be clear, the action definitely does NOT always provide information. No, there is an awful lot of “noise” in the markets these days due to the algos running the show.

My guess is you’ve heard the old saw, “It’s not the news, but how the market reacts to the news that is important.” Cutting to the chase, I believe there is a message to be received from this morning’s “action.”

In my humble opinion, today’s continued rally in the face of record-breaking bad news is an indication that the market MAY (note the use of all capital letters) have priced in a healthy amount of the bad news that will be coming our way on both the virus and economic fronts.

Exhibit A: A Jaw Dropping Report

Exhibit A in my thinking is the market is basically ignoring the jaw-dropping report that the government received 3.28 million new claims for unemployment this WEEK. We knew this report was going to be bad, as the consensus expectation had been for 1.5 million. So, the fact that stocks are rallying (and not just spiking) this morning is encouraging. Well, to me, anyway.

Don’t Forget About…

I have a couple other thoughts I’d like to share this morning. First, we should recognize that we’ve got “quarterly rebalancing” in the mix here. With stocks down big and bonds having exploded to the upside, every investor, every financial advisory firm, and every portfolio manager that is set up to rebalance quarterly will be selling bonds and buying stocks. The bottom line is traders know this and appear to be front running the move.

Sticking To The Script

Next, before we throw caution to the wind and jump back into the pool, let’s remember that a bounce up – “a move that makes you feel like everything is all better now” – is a big part of the crash playbook. As such, it looks like the market is sticking to the script right now.

Next Up Is…

So, the next chapter in the script is a retest of the lows. Looking at the history of market crashes/panics, we see that the market tends to retest the initial lows. Not always (December 2018 is an example of an exception.)

In short, markets tend to retest the lows as a result of human emotion. As we’ve discussed a time or two, the thinking is that after a sigh-of-relief rally retraces a healthy percent of the crash (typically 30-40% and the next logical target is 2650ish on the S&P 500), the original reason for the panic resurfaces. Logically, this would include the dire economic data and the wretched human toll that is likely coming our way in the next few weeks.

As such, it is important to keep in mind that a retest of the lows remains a strong possibility. History (and the computers at Ned Davis Research) shows that the initial low is even broken about 70% of the time. So, we need to be prepared for this event.

The key is that if the market sticks to the script, there will likely be plenty of opportunities to “get in” over the next month or so. This is important to keep in mind because entry points are definitely tough to come by during the sigh-of-relief phase.

Glancing At The Macro View

Next, we need to look at the macro picture. From my perch, the key question for the economy is, what letter are we dealing with? This is in reference to the shape of the anticipated economic recovery. Options include: V, U, W, L, and my personal favorite, which comes from this weekend’s Barron’s, is “an L popping a wheelie.”

The two questions here are (1) how strong and (2) how swift will the recovery be? Will consumers and, in turn, the economy, return immediately to business as usual? Or will there be some caution going forward? (If there is caution, this would argue for the L popping a wheelie.)

Obviously, nobody knows the answers here. And this is what the market will be “dealing with” via the “price discovery” process going forward.

Good News: Valuations Have Improved

Finally, I’d like to share some good news. I think it is worth noting that valuations are greatly improved after the 30% trashing stocks have been hit with. For example, one of NDR P/E models shows that the S&P 500 has fallen into the “fairly valued” zone. The model says the S& 2334 represents the median “fair value” from 1964. This is interesting due to the fact that stocks have been pretty overvalued for quite some time.

But, we should also keep in mind that during bear markets, the market often creates an undervalued condition.

I will argue though that since this is a bad-news panic bear (my personal favorite moniker is “The Corona Crash”) I don’t expect stocks to reach the “undervalued” level. This is largely because one standard deviation below the median fair value (i.e. the undervalued level) currently stands at S&P 1616, which would require a drop of 52.3% off the 2/19/20 high.

Sure, this could happen. My guess is that the virus situation would have to become (a) prolonged and (b) produce more damage than is currently assumed in order for this to occur.

Summing Up

In sum, I am encouraged by the action so far this morning and I believe there may be a message to be received. As such, my plan (which we began implementing on Monday) for the days/weeks ahead is to continue to work a strategy designed to take advantage of the coming bull market.

NO, we will NOT try to catch the bottom – I believe trying to is a fool’s errand! The idea is to try and put our offense back on the field in a manner that will be satisfactory looking back a year from now.

Thought For The Day:

Panic selling occurs when people believing “this time it’s different” sell to those who know it’s not. -Unknown

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: None

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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