Back To Back Declines
The stock market wasn’t heavily overbought heading into the recent back to back declines. But it was getting expensive as the S&P 500’s forward PE ratio was about 19. When stocks or a market are expensive, anything can take them lower. If the market starts to realize Bernie might win the Democratic nomination in the next few weeks, we could see much greater volatility than we did this week.
If the stock market were to crater because Bernie is doing well in the polls, it would help the moderate candidates’ arguments against him. However, many view him getting the nomination as a ticket to President Donald Trump winning re-election.
On Friday the stock market fell; it didn’t recover intra-day like it did on Thursday. The S&P 500 was down 1.05%, the Nasdaq fell 1.79%, and the Russell 2000 fell 1.03%. Journalists blamed the coronavirus for the market’s decline because that’s the vogue thing to do just like how last year every market movement was blamed on trade. It’s clear that not all firms have quantified the negative impact of the coronavirus, but this is still a one-time factor which is winding down.
On February 21st, the coronavirus infected another 297 people and killed another 109 people. Thursday’s number of new cases was revised up from 394 to 820. There were 142 new cases on South Korea which brought the total to 346. The market sold off not because of the coronavirus, but because of the weak Markit report which was due to the coronavirus.
A most likely day for volatility to spike due to the Democratic primary race is March 4th which is the day after Super Tuesday.
Retail Trading Has Exploded
VIX was up 1.52 to 17.08 which is a slightly elevated level. Because volatility usually clusters, there is room for the VIX to go higher. Nevada caucus could be causing angst among traders or maybe they are worried about Bloomberg’s bad debate performance. There haven’t been many polls after the debate, so we don’t know how it impacted the election. If Bloomberg drops, the market could sell off.
CNN fear and greed index fell from 49 to 44 which is fear. It’s over the top to say stocks are oversold considering the recent returns. This index could easily start getting to extreme fear in the next few weeks. As you can see from the charts below, retail trading has exploded in the past few months. It would be interesting to see them get wiped out with some volatility.
However, don’t be too contrarian in your positioning because the cycle isn’t about to end. Don’t be bearish just because free stock trading has encouraged more non-professionals to trade. There aren’t any signs of a recession and EPS growth will accelerate after the transitory impact of the coronavirus is over.
Record Low 30 Year Yield
As you could tell by the decline in the Nasdaq, the tech sector had a bad day. It was down 2.25% as it was driven lower by Microsoft which fell 3.16%. Microsoft is still a great company; it just rallied too far too fast. I’d buy it if it sold off further. Despite the big rally in the long bond, utilities fell 0.18%.
This gives you a potential signal that the rally is over in this sector. Personally, I wouldn’t go near it. Biggest winners were consumer staples and real estate which rose 0.28% and 0.38%. Friday was a mostly risk off day. Heath insurance industry only fell 0.33%. I predict it will have a weak March.
Biggest story of the trading session was that the 30 year yield fell below 1.9% which was its prior all time low. It ended up selling off 4.6 basis points to 1.918% as it bounced off its record low. This decline is great news for house buyers as mortgage rates might hit a record low in March. 10 year yield fell 4.4 basis points to 1.475%.
As you can see from the chart below, the yield curve has flattened 21 basis pints in the past few weeks. We might see another inversion. The market is pricing in 2 rate cuts later this year. Because of this big decline in yields, gold has rallied sharply. It was up 1.57% on Friday to $1,645.9. Personally, I’m bearish on the long bond, despite being wrong recently, because I see a cyclical turnaround.
2020 Democratic Primary Update
Betting market now has Bernie Sanders with a 57% chance if winning the nomination. Bloomberg is at 20%. Bloomberg’s odds keep falling as his weak debate hurt him in the polls. Fact that Bloomberg is in this race helps Bernie. Most of the attacks are being leveled against Bloomberg even though Bernie is the front runner.
There were 3 new polls released on Friday. There were 2 new Nevada caucus polls. Bernie was up by 13% and 19% in them. Election is this Saturday. He is likely to win. There also was a poll of Massachusetts which is Warren’s home state.
Bernie is winning by 1 point over Warren. That poll was from the 12th to the 19th which means it didn’t capture any momentum Warren may have gotten from the debate.
Conclusion
Stocks can sell off in the short term even though many indicators don’t show stocks are overbought. And the long bond yield is due for a pullback. It is overbought based on the growing economic momentum outside of transitory factors.
Bernie will do well in Nevada and has a good chance to win the nomination which is why many are bearish on the health insurers. There's no reason to be afraid of buying stocks because people are opening a lot of E-Trade accounts. Just look at valuations and the economy. It doesn't make sense to go bearish because of new money coming in from retail traders.