Markets just suffered their worst week since March as US indices fell between 5-7% to cap off a month that finally lived up to its volatile potential. Unfortunately for all of us who have lived through COVID-2020, the reversal tendency of this tricky month wasn’t from the downside to upside, but ostensibly, the opposite.
To many, this weakness was long overdue, as the COVID resurgence gripping the world along with lack of a stimulus package was worrisome to investors. Markets weakened, as bad news arrived. Easy enough to explain, and makes perfect sense.
In reality, the bad news has been with us for some time, and hardly has had much effect on stocks since the March lows. Economic progress, while impressive in recent quarterly GDP, still leaves the economy down nearly 4% from the pre-crisis peak. Furthermore, the COVID uptick was something that’s seemingly been gaining momentum for weeks now as reopening efforts and more testing occur.
Furthermore, all US investors have had to deal with potentially the most polarized election climate of all time, and have heard that the polls remain narrow between Biden and Trump. Stimulus efforts had been thought to be the key lynchpin that could potentially aid stocks if passed. Yet as might be expected in a surreal year like 2020, the gridlock won out over success, for now.
The buying that had greeted these Large-Cap “Fang” names suddenly dried up and gave way to selling. The real question from a non-technical perspective is, did the fact that narrowing election polls combined with lack of stimulus and a more rapidly expanding virus all come together as the perfect tsunami in mid-October? Potentially.
However, as non-fundamental purist of what drives price action, I would note the following: breadth and momentum did unfortunately begin to wane sharply as of mid-October. That was the first negative warning.
Technology began to drop off in relative strength, another negative which we’ve discussed in recent weeks. The US dollar also began to turn up sharply a couple weeks ago, coinciding with Europe embracing lockdowns which adversely affected pound sterling and euro. Many are aware of the inverse relationship recently between USD and stocks.
In addition, implied volatility seemed to sniff out the potential for late-October weakness, as it finally began to strengthen in a way that had been previously absent in recent months. (Spot VIX moved above recent 2 and 3-month futures prices rapidly to produce backwardation.) Furthermore, defensive trading came back with a vengeance, and we saw massive outperformance from the Utilities, despite the fact that yields were rising.
Most importantly, uptrends broke for the S&P, DJIA and NASDAQ, which was the first instance of technical price weakness confirming. Finally, sentiment actually got more bullish as October continued, showing a real “cognitive dissonance” to the idea that markets might actually weaken in October, despite the Fed having come to the rescue.
Bottom line, all these factors seem to be important and negative in what steered stocks from higher, to lower very quickly. Unfortunately, as we’ve all come to realize, investors are rarely adept at analyzing all the data, and selling out of stocks correctly at the top at the first hint of bad news. If anything, most selloffs emanate from a drying up in buying precisely when investors are expecting more.
So what’s to expect this month?? Unfortunately, that uber-hopeful scenario in which elections come to pass, it’s a relief and markets rally back to new highs, seems a bit far-fetched. This post Halloween “treat” is much less likely than a month-long “trick” which very well could carry on into December. Most technicals still remain pointed lower in the short run and momentum is downward sloping and not oversold.
The necessity of Technology regaining its footing remains very important to the bullish view. Yet market cycles which have stood the test of time argue for further weakness this month, suggesting Q4 2020 should turn out much more like 2018 than most seasonal times of success when fall declines pave the way for holiday rallies. This time around, our fall rally showed initial signs of faltering in September and now has turned back down ahead of the election, with Europe having taken the lead on the way down but also evidence of Asia having made some important weakness, from countries like Japan.
Bottom line, late September lows are critical to hold in the days ahead for any sort of stabilization effort. The violation of this level by SPX, NASDAQ points to another 5% decline before any meaningful bounce can take hold. While conventional wisdom says that markets likely view the passing of the election to help uncertainty decrease, my thinking is that this only happens if there is a conclusive victory for either side. Technically, selling rallies and maintaining a defensive stance remains prudent until some evidence of trend improvement occurs.