Department of Correction: DJIA, SPX On Verge of 10% Drop From Peak As Virus Spreads

The major indices are on the verge of a 10% decline from recent highs, which would officially mean the market is in a correction for the first time since 2018. Bond yields forged new record lows and volatility is surging.

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Key Takeaways

  • VIX moves above 30 as virus anxiety rises after case of unknown origin in California

  • S&P 500 just above key technical area near 3050 as 200-day moving average threatened

  • Crude hits new 14-month low and bond yields forge new record lows

(Thursday Market Open) A correction appears imminent. Major indices are set to start out 10% below their recent highs, the first time that’s happened since late 2018.

Fear still has a tight grip today, and unlike fear around something financial like a trade war or rate hikes, it’s hard to say when this anxiety will let up. Stock futures slipped after the Centers for Disease Control and Prevention (CDC) confirmed the first U.S. coronavirus case of unknown origin in Northern California, indicating possible “community spread” of the disease.

That’s probably not all that surprising, but does raise a red flag around the U.S. consumer. One consistent theme over the last year is U.S. consumer health. If people start getting scared and staying home due to the virus, that could have a chilling impact on the economy after it weathered the trade war last year. Online shopping could ease the pain, but it still represents just a small percentage of consumer activity overall.

Bond Yields, Crude Slammed as Volatility Heats Up

For a leading example of where fear is taking things, check the bond market. The benchmark 10-year Treasury yield fell to 1.28% this morning, another record low. The 30-year bond rate is also trading at an all-time low near 1.76%. 

The Cboe Volatility Index (VIX) just ticked above 30 for the first time in 14 months. Crude has completely lost its footing and trades just above $47 a barrel, almost a 14-month low. All this is a big contrast to 24 hours ago when crude and yields showed signs of stability and VIX had eased off slightly. 

The S&P 500 (SPX) is now shouting distance from the 3050 technical area we talked about yesterday (see chart below). That’s just a few points above the 200-day moving average, and a serious drop from there would probably do more technical damage to the market and possibly lead to an additional wave of selling. The 3050 area also happens to be about 10% below recent peaks.

The Dow Jones Industrial Average ($DJI) looks like it might take out a key support level near 26,700 as the session begins. That level marks about a 10% drop, or an official correction, from recent highs. It’s also a level that was tough resistance a couple of years ago when the $DJI struggled to claw above it.

Two very high-profile shares got rocked in overnight trading, with Apple (AAPL) down 3% and Microsoft (MSFT) down 4%. More and more companies, including MSFT, are warning about the coronavirus affecting their quarters.

Rough Ride Seen Continuing

There’s no sign of volatility putting its feet up any time soon, and that should come as no surprise. When the markets get rattled the way they did Monday and Tuesday with 3% losses each day (something that hadn’t happened since the financial crisis of late 2008), it’s like a bell getting rung, and the vibrations can last long after the last chime. 

The volatility curve, which measures risk into the coming months, appears to reflect investor expectations that the virus is more likely to become a normal illness that humanity has to deal with and maybe not a doomsday scenario that the market was pricing in Monday and Tuesday. Investors have been wrong in the past, of course, and because the virus is a medical issue and not a financial one, any long-term expectations about where it might go have to be taken a little less literally than, say, expectations for a possible rate cut.  

Investors might have to get used to these levels as we approach March, especially with election season looming. Some analysts have even said some of the recent selling and volatility might reflect concerns about the Democratic primaries. There’s some who worry that a nominee might emerge who’s seen as unfriendly to the financial markets, with more regulation possible.

Fed Taking A Longer Look

Even if the Fed took emergency measures, it might not help that much. Instead, it’s possible investors would see that as a sign of desperation. So far, the Fed has sounded like it wants to wait and get more information before doing anything. Chances of a rate cut next month keep ticking higher, landing at around 36.5% by the end of the day yesterday, according to CME Group futures.

Almost every sector finished in the red again Wednesday as the bleeding continued. Energy got the worst of things as demand worries dominated and U.S. crude futures fell below $49 a barrel for the first time in nearly 14 months. The SPX hasn’t had a positive day since Feb. 18, more than a week ago, and now down more than 8% from its highs.

Looking for good news? Keep checking the data. New home sales for January, announced yesterday, came in well above expectations after last week’s strong reading on housing starts. Mortgage rates have come down lately due in part to the bond rally, so maybe that’s helping fuel some of the housing strength. New home sales climbed 7.9% in January to a seasonally adjusted annual rate of 764,000 units, compared to the Briefing.com consensus view of 720,000. Sales rose 18.6% from a year ago, partly reflecting low rates but also the low supply of existing homes, Briefing.com noted.

In a report that’s probably getting less attention than usual, the government said Thursday morning that Q4 gross domestic product rose 2.1%. That was in line with analysts’ expectations and probably won’t have much impact on trading. Weekly jobless claims rose to 219,000, a bit above where analysts had projected but nothing alarming. Durable goods fell 0.2% in January, which was a lot better than analyst projections.

Meanwhile, Goldman Sachs (GS) now sees zero earnings growth this year for U.S. companies because of the virus. The Atlanta Fed’s “GDP Now” indicator is due for an update today and was last at 2.6%. We’ll see where it lands.

A Little Relief Wednesday but Early Turnaround Attempt Failed

Wall Street’s struggles continued Wednesday as two of the three major indices erased 1.5% morning rallies, but the bloodbath of Monday and Tuesday didn’t repeat. It was encouraging to see the Nasdaq (COMP) manage a slight gain Wednesday as some of the beaten-down chip stocks like Micron (MU) and Nvidia (NVDA) rose.

The FAANGs also showed some life Wednesday, led by AAPL. This stock is such a bellwether that its progress or lack of progress the next few days could help guide the rest of the Street. MSFT has some of that same kind of influence and enjoyed a bit of a rally yesterday, too. Their rallies yesterday seem like a long time ago now. 

Even if it didn’t last, it was nice to see some investors apparently “buy the dip” in the morning hours yesterday. It was discouraging not to see that hold up into the later part of the session, but maybe that reflected some remaining sales interest from the previous two days and sellers taking advantage of slightly higher levels.

Also, news of more cases in Germany probably helped sap a bit of the confidence that had been developing. For the moment, we’re living in the shadow of possible negative virus news at any given moment, so that might be enough to put more caution into people than you’d normally see after a sell-off. 

Investors got another reminder of the danger after the close yesterday when MSFT warned that it will miss its guidance for the segment that includes Windows, blaming the miss on coronavirus. It’s no coincidence that tech has taken one of the biggest punches so far, with chip firms, MSFT, and AAPL so reliant on Asian customers and supply chains. Airlines, hotels, and stocks of entertainment venues like movie theaters continue to struggle, as well.

That’s what you might expect with flights to China apparently seeing little demand, casinos closed in some parts of Asia, conferences being canceled and health officials going on television advising people not to shake hands if they can avoid it. On the other hand, biotech stocks, where a vaccine would seem likely to come from if anywhere, are getting some love. The Nasdaq Biotech Index (NBI) rose more than 1.2% yesterday, led by a 22% jump in shares of Moderna (MRNA), which said a coronavirus vaccine is ready for tests. Remember, though, that health officials believe the vaccine wouldn’t be ready until a year from now, even if it goes very quickly through trials. It’s not a panacea.

Friday represents the chance of more profit-taking ahead of the weekend. Fridays are rapidly getting a bad reputation around the Street, with six of the last seven Fridays featuring market declines. There appears to be a lot of fear about going long into the weekends with this overhang. 

CHART OF THE DAY: HEAD ABOVE WATER—FOR NOW. This one-year chart shows the E-mini S&P 500 Index Futures (/ES—candlestick) and its 200-day moving average (200 MA—blue line). Note that the current 200 MA sits at around 3048, and that /ES closed below the 200 MA twice early last year but quickly recovered each time. It also tested the 200-day later in 2019 but again bounced. We're starting the day with /ES just above the 200 MA. Might we test that level and will we see some support? Stay tuned. Data Source: CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Sick-licals: The cyclical sectors, including Energy, continue to get pounded. Looking back over the rubble of the last five days, Information Technology has definitely gotten the worst of it, down more than 9%. Energy is off nearly 9%, while Industrials, Communication Services, Consumer Discretionary, and Materials have all slid more than 7%. Financials are down almost 7%, which isn’t too surprising when you see the 10-year Treasury yield falling below 1.28%. That’s a new all-time low, taking out the previous low from June 2016. Another leg down in yields from here would probably be seen as a pretty bearish economic signal. 

What’s Typical? A 10% decline in the markets happens around once a year, on average, history tells us. So although the steepness of this week’s selloff wasn’t typical, it is typical to see things ease double-digits now and then. A 10% drop from the peak is called a “correction,” and it would take a 20% hit for a bear to prowl. We almost got there in the SPX during December 2018, but just missed. An actual bear market hasn’t happened since the 2007–2009 financial crisis, but remember that many analysts believe fear, not age, tends to kill bulls. That was definitely the case in 2008, but now there’s a sense among some analysts that the market won’t likely go into bear territory unless investors become convinced the virus can send the economy into a recession. Stay tuned.

Record industry spinning:  After getting pushed aside first by CDs in the 1980s and then more recently by streaming music, the old-fashioned vinyl LP came back big-time in 2019. Sales rose 14.5% in the best  year for turntable lovers since 2005. Now that’s in danger of an unexpected scratch. A fire earlier this month left nothing but a shell of a California factory that made 75% of a key component in LPs, the Los Angeles Times reported. The facility housed Apollo Masters, which makes black lacquers, the shiny circular plates essential for the production of vinyl records. Though records accounted for only 4% of U.S. music sales last year, it’s a growing business that appeals to hobbyists looking not only for new releases but for remastered versions of big hits from the 1960s and 1970s. Only one other facility in the world makes the lacquer needed, and it’s at peak production and not taking on new clients, the paper reported. At this point, it’s unclear if this is the day vinyl music died or if the beat goes on.

Good Trading,

JJ

@TDAJJKinahan

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This week's economic calendar. Source: Briefing.com
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Key Takeaways

  • VIX moves above 30 as virus anxiety rises after case of unknown origin in California

  • S&P 500 just above key technical area near 3050 as 200-day moving average threatened

  • Crude hits new 14-month low and bond yields forge new record lows

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