Doom and Gloom views of the stock market are always an easy sell. Fear is an exceptionally strong emotion, not as predominant as Greed (which influences investors to hold stock even when they are on losing positions), but certainly an instigator for investors to panic sell stock holdings. Especially at the most inappropriate time, and more frequently than not, at the bottom of the market.
With the S&P500 index stalling beneath 1,900 points over the last two months, and more recently the Russell2000 (Small Cap) index down nearly 10% since early March, investor confidence is starting to waver. So what could be the triggers for this market to crash?
Economic strength slowing
First and foremost, weaker economic conditions. The US economy is currently reporting an annual 2.3% GDP growth rate. This has improved from a low of 1.3% in 2013, however, has declined from the Q1 2014 peak of 2.6%. If another decline in GDP growth is reported, this will be the first signal of a Recessionary environment.
US Inflation is also increasing, and is currently at a 2-year high of 2.0%. Although this is quite a low figure, it is starting to shift towards a level that may instigate a change in Interest Rates. As was reported on Tuesday, comments from Philadelphia Fed President Charles Plosser, “the economy is on its firmest footing since the [economic] recovery began”, which hints towards the potential of Interest Rates rising sooner rather than later.
China is also a major player in the global picture. Their annual GDP growth rate is trading at long-term lows of 7.4%. Further contraction in GDP activity will trigger panic selling on a global level. At the same time, reports that the Property Bubble has burst in China are spooking the global markets. Financial analysts from the Japan based Nomura Group issued a report recently stating “To us, it is no longer a question of if but rather how severe the property market correction will be.”
International Monetary Fund
The International Monetary Fund (IMF) reported in their World Economic Outlook in April, that “global [interest] rates can be expected to rise in the medium-term, but only moderately”. So the key question here is whether or not the global economy can withstand a rise in interest rates whilst currently in a slow/weak growth period?
Although the IMF maintains a slow growth outlook globally, the reduction in stimulus measures in the US are of great concern as the unknown factor is whether or not the economy can stand on its own two feet. Include the slowing Chinese economy into the mix, and any signs of weaker economic data could be the trigger for further selling pressure.
Flight to Safety
When stock investors begin to panic, there is a phenomenon referred to as the ‘flight to safety’. This involves selling stock, buying the Volatility index (VIX), buying bonds, buying gold, and buying Blue Chip stocks.
In recent weeks, we have seen Treasuries rally with bond yields declining. This is the first signal that investors are reducing Risk in the stock market, and purchasing lower return investments that provide reduced Risk exposure.
A low yield from Bonds reflects that investors are willing to hold an investment that has a very low return in an effort to avoid the volatility or uncertainty that the short-term outlook of the stock market is providing. As of Tuesday 20th May, the 10-year Treasury notes fell to 2.51%, a yield that is near a 6-month low.
Blue-Chip stocks recently pushed the DOW Jones Industrial Average to a new all time high. This has failed to hold up, however, with the broader market selling off over the last week. So while there was an initial drive of Blue Chip stocks, we are now experiencing some uncertainty in this market segment as well.
What we haven’t seen, in terms of flight to safety, is a significant shift in the VIX (Volatility Index) or buying of Gold. The VIX is also referred to as the “investor fear gauge”, reflecting panic selling by rising in value when the stock market falls. It is currently trading at long-term lows, and at a range that would denote speculative hedging as a means to offset any Risk of stock ownership.
Gold has also maintained a very tight range over the last month. A sideways range will not last indefinitely in a commodity such as Gold, but in which direction will it break? This will depend on what the markets decide, but at the moment, there is no leading indication that investors are buying into Gold as a means to reduce stock investment Risk.
Contradicting Index activity
Finally, a review of leading stock market indices helps provide insight into the broader market sentiment.
We have already mentioned that the DOW Jones Industrial Average recently broke into a new high, but has declined slightly in the last week. It still maintains an upwards trend, although is now testing the short-term support. Further downwards activity could see this Blue Chip index retracing towards the next primary support level at 16,000. A break of that level will denote a change in trend.
The S&P500 index is showing that momentum has declined sharply, with Bearish Divergence on the Stochastic indicator supporting the slowing in the trend movement. While the long-term uptrend remains in place, there is a strong argument for a trading range having formed over the last two months as Resistance at 1,900 continues to hold. Should a trigger of selling pressure occur, the S&P500 could retrace towards 1,800, even 1,750 if there is panic selling (based on previous support levels).
Russell2000 and NASDAQ
The Russell2000 represents Small Cap stocks in the US. It has declined 10% in the last 2-months and is trading just above the previous low point. A medium-term downtrend has already formed with the 20/50 moving average combination also denoting a downtrend. A break of 1,180 would confirm a change in longer-term trend, and could instigate further selling across the broader market.
For the Technology driven NASDAQ index, it is a very similar picture to the Russell2000. It is consolidating sideways above 4,000 support, but has broken the previous upwards trend. Investors will be very wary of any news that triggers a break of support.
This is not a time to panic sell and run for the hills. The economic data, whilst showing weak growth, is not defining a contracting environment just yet. There’s still hope, or should we say potential, that continued stimulus measures will maintain the current environment and lead to improved conditions later in the year.
As a Technical Analyst, or Chartist, the measures we use to define that a Bear market has formed is a break below the 50-day moving average, and a bearish crossing of the 50/100 moving average combination. Neither of these have occurred on the S&P500 index at this point, although the Russell2000 and NASDAQ indices have confirmed these bearish alerts.
When all leading indices trigger the technical downtrend indication, with the VIX rising, this is when Bear market strategies will need to be implemented.
Matthew Brown – US Stocks & Options specialist
US Equity & Option Client Advisor
Halifax Investment Services
ASIC Australian Financial Services License Number – 225973
Matthew is an Authorised Representative of Halifax Investment Services (Halifax). Halifax provides broker services, including Full Service and Discount Services using multiple trading platforms.