Weekly Market Update 02/02/2020Posted Feb 03, 2020
The S&P 500 declined -2.12% this week with Friday's close at 3,225.52. The index has now declined two weeks in a row and is -3.12% below our all-time high weekly close. The S&P 500 opened the week with a case of the Monday's, and seemingly ended the week not feeling so hot. Monday saw the index trade down -1.85% from last Friday's close, with the narrative being the uncertainty surrounding the coronavirus. The S&P 500 then staged a mid-week comeback.
Collectively, earnings came in mostly at and around consensus expectations, and the S&P 500 climbed all the way to 3,293.47 at Wednesday's high. Thursday then saw a fairly large upside reversal with the index trading down nearly -1% during the session, only to finish in the green by 0.31%. Amazon then reported blockbuster earnings after the bell on Thursday, and so it felt like Thursday's close set the stage for further upward extension on Friday, with "felt" being the key word. This is yet another reason why feelings have no business in the world of investing, because on Friday the S&P 500 decided to throw a serious sucker punch...
Friday saw the index decline by -1.77% and evaporate all of the month of January's progress. We're unsure of the narrative behind Friday's price action, and we never truly know why the S&P 500 does what it does, but one idea could be ascending uncertainty on the manufacturing front, given Chicago PMI's big miss on Friday morning (click here). That said, we can't say we're at all surprised that the S&P 500 is indeed taking a "breather", even if Friday's plunge was definitely surprising.
In last week's Update we wrote:
"Speculatively speaking, we continue to believe the S&P 500 will clear its "overbought" condition over the weeks ahead by either trading down into the ~3,150-3,200 price region, or by trading sideways and consolidating before beginning the next leg higher."
Weekly declines of this magnitude help to clear the S&P 500's "overbought" condition. It's through these lenses where this week is a good thing. Remember, the best of returns don't follow grotesquely "overbought" conditions, they follow meaningfully "oversold" conditions or normalized conditions. This is the basis of Warren Buffett's famous quote: "Be fearful when others are greedy, and greedy when others are fearful". "Oversold" conditions generally bring out a healthy dose of fear...
Two weeks ago we told our readers not to fall in love with their current account balances. We reminded our readers that unless this time was truly different (hint, it's almost never different through technical lenses), you were probably going to have to give some of the money you've made the last three months back to the house in the not too distant future. Well, the house took some money back this week, and the average long-term investor has a little less money in their account as of this week's close. That said, this is a permanent feature of long-term investing; being tolerable to temporary losses in exchange for even greater gains over time.
As we look to the week ahead, there's undoubtedly further volatility coming. There's a variety of objective support levels we can reference where the S&P 500 should find its footing. Referencing the chart below, the 50-day simple moving average (50MA) is presently at 3,211.30 and ascending. Quite frankly, we'd be shocked if the S&P 500 didn't trade down below the 50MA next week, perhaps even on Monday.
The lone catalyst to a positive Monday would be some sort of overwhelmingly favorable developments with the coronavirus over the weekend, which seems very unlikely. Should the 50MA not hold, we'd then turn our attention to the mid- 3,150 price region (top third of the yellow shaded box). With the Volatility Index (VIX) closing the week at 18.84, it's reasonable to expect the price of the S&P 500 to move fast over the coming week, with implied volatility suggesting moves of +/- 1% per day. The seat belt light remains turned on.
Bottom line: After an incredible ~16.59% rally over a 15-week stretch, where the index increased 13 of 15 trading weeks, we're finally taking a break. At the moment, the break is as normal as it gets. That said, we only know this with hindsight, and we truly have no idea how nasty the next few days/weeks could get (nobody does).
Our work leads us to believe that yellow shaded region on the chart above will represent meaningful support to the price of the S&P 500, especially if we trade down near the ~3,100 level. So, we're experiencing turbulence, it's normal turbulence, and long-term investors should treat this bout of volatility like they treat real-life turbulence; by staying calm, relaxed, and understanding that "this too shall pass". It won't derail us from landing at our final destination.
S&P 500 Primary Trend - Up
The S&P 500 finished the month of January on Friday. January saw the index decline by -0.16%. In last week's Update we discussed the idea of the S&P 500 recording a 5-month winning streak, along with the idea of the S&P 500 recording 5 consecutive monthly advances of 1% or more, and given Friday's price action we can't help but feel like we jinxed it.
As of January's close, our work continues to label the primary trend as up or "bullish" for the S&P 500. During uptrends, long-term investors are best served maintaining an equity overweight across their portfolio's asset allocation and relying mostly on passive, or strategic, asset allocation methodologies. It isn't until the primary trend can be labeled as down, or "bearish", that long-term investors (especially those withdrawing money from their portfolio to meet their income needs) need to "batten down the hatches" via tactical portfolio rebalancing (in our opinion, of course).
So, the question then becomes whether or not January's downside reversal is a sign of an impending reversal in the S&P 500's primary trend, from up to down. The odds will always say the answer is no, if for no other reason than sustained downtrends being so rare (there's effectively two of them the last ~30 years). That said, market participants, collectively, were eager sellers into January's monthly close. The price action has a hint of distribution associated with it. Naturally, we quantified what transpired.
We defined the month of January as a calendar month that traded up by 3% or more at some point during the month and also recorded a fresh all-time high in the process, only to then finish the month in the red. The picture this paints is that of eager selling pressure into all-time high prices for the S&P 500. There are only 10 calendar months that match this criteria since 1970, and interestingly the S&P 500's forward-looking returns have been decidedly below average over all measured time periods on the table below (click to enlarge). For example, the S&P 500's average forward 12-month returns following months like January record at just 1.62%.
However, perspective is necessary here. The above table is a crime of small numbers, and there's nothing we can truly take away from 10 samples over nearly 50 years. I can hit 10 free throws in a row, probably one out of every 15 instances of shooting 10 free throws, but that clearly doesn't make me a good free throw shooter. Furthermore, January's monthly return was just -0.16%, the lowest of the dataset, whereas the average monthly return of the prior 10 samples is -2.09%. Had January closed the month at 3,163.25 (a -2.09% monthly decline) after trading up to 3,337.77, we'd be a bit more concerned.
Finally, one slightly red month can't erase all of the good that transpired the previous four months. The S&P 500's decline in January was not the most preferred scenario, and further uncertainty regarding the coronavirus isn't the most preferred scenario either, but as the great Bill Belichick would say, "we're on to February".
Random January Happenings - Lots of Boom & Bust
January saw a lot of extreme price action across the investable universe. Here are some of the highlights:Once upon a time, the price action in copper was viewed as a bellweather for the global economy. The metal even earned the nickname "Dr. Copper". Well, copper declined -10.01% for the month of January, closing at its lowest level since late 2016. Copper's been range-bound and volatile for years. It makes a -10.01% monthly decline look like business as usual on the monthly chart.
Now, copper hasn't been remotely close to "Dr. Copper" for years, i.e., weakness in copper obviously hasn't preceded weakness across risk assets or the global economy. But there has been a connection between copper's price action and Chinese equities, which have also been range-bound and volatile for years. Perhaps participants in copper are actually pricing in the coronavirus impact to the Chinese economy.
Crude Oil Plunges, Energy Stocks Collapse
The price per barrel of crude oil (WTIC) fell -15.56% in the month of January. Like copper, WTIC has been range-bound and volatile for more than a decade. WTIC closed the month of January at $51.56, a level first reached in 2005.
WTIC's price action has had a negative impact on the price action in the S&P 500 energy sector (SPEN). SPEN fell -11.18% in January, underperforming the S&P 500 itself by more than -11%. Everyone, and I mean everyone, is aware of the underperformance in SPEN over the last decade. We can't help but think there are opportunities in the sector on a forward-looking basis, if for no other reason than it feels a bit crazy to think SPEN will outperform into the future. It's analogous to betting on the San Diego Padres to win a World Series over the next five years - nobody believes it's possible - but they're probably only a Mookie Betts away from being a serious contender (click here).
Like WTIC, SPEN has done absolutely nothing for ~15 years. If you have a SPEN overweight in your portfolio, you're living dangerously. If you're not watching SPEN to identify the appropriate time to overweight the sector in your portfolio, you're also living dangerously.
Bond Prices Surge, Interest Rates Collapse
The price of a 30-year United States Treasury bond (USB) surged 4.94% in January. This left the yield on a 30-year United States Treasury bond (UST30y) at just 1.99%, the second lowest monthly close in the history of UST30y, just an inch above the all-time low monthly close of 1.96%.
The yield curve is flat as a pancake and slightly inverted at the moment. A 10-year United States Treasury bond presently yields 1.51%, while a 3-month United States Treasury bond yields 1.55%. This certainly supports the lower for longer narrative, along with the idea that market participants in the treasury space, collectively, have muted forward-looking expectations for growth and inflation. It's also the market's way of telling the Federal Reserve that they need to lower the federal funds rate. Collectively, participants in the federal funds futures market are now pricing in a rate cut in June, with 1%-1.25% being the most probable federal funds rate at the end of 2020.
The implications here for long-term investors are meaningful - they have to analyze the effectiveness of the bond/fixed income asset class across their portfolio, and understand alternative investment opportunities that have a greater forward-looking stream of cash flows. Further, we all might have refinancing opportunities in front of us yet again. Imagine borrowing money for 30 years for less than 3%? It's a distinct possibility here in 2020.
Bitcoin exploded 30.04% in January. While the asset class remains in its infancy in terms of being a reputable investment to consider for portfolio inclusion - anything that can behave uncorrelated to that of both stocks and bonds, especially during time periods of volatility for stocks, is going to garner attention. "Digital gold" was in full effect in January.
Steve, Rick, and the AlphaCore team
P.S. We like the team with red in their logo to win today!
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