Written by Jim Welsh
Special Update – Weekly Technical Review 27 February 2020
Since peaking on February 19, the S&P 500 has suffered its largest decline from a high in history falling from 3393 to 2979 on February 27.
Note: This is the second daily update following the one yesterday.
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In an interview with Ike Iossif on Market Views on Tuesday February 25, Ike asked me what levels could be expected to provide support for the S&P 500. I told Ike in a market like this there are no levels of support (5 min – 6 min).
One can look at the chart of the S&P 500 and identify price levels that previously provided support, but in the middle of a dynamic decline (panic) no one cares. More often than not, the 200 day average provides at least temporary support for the S&P 500. Coming into today the 200-day average was 3047 and the S&P 500 sliced through it as if it wasn’t there.
The intensity of the current selloff has been historic but similar to other high energy declines. In August 2015 the S&P 500 peeled off -11.2% in just 4 trading days after China devalued its currency. The 5-day average of Advances minus Declines reached a -1953 far below the green horizontal line measuring oversold at -1200. In the following 16 trading days the S&P 500 rallied +8.2% only to fall and retest the initial low. The 5-day average of Advances minus Declines recorded a higher low (-1104) as the S&P 500 tested the prior low before reversing higher.
In early January 2016 the S&P 500 dropped -12.9% in 16 trading days and the 5-day average of Advances minus Declines reached -1326, in a response to a plunge in oil prices. In the subsequent 8 trading days the S&P 500 bounced +7.4% before falling back to the original low on January 20. On the retest the 5 day average of Advances minus Declines produced a positive divergence as it fell to -1035, well above -1326.
After peaking in January 2018, the S&P 500 dropped -11.8% in just 9 trading days, only to rally 10.6% in the following 19 trading days. This big rebound was followed by a retest of the initial low. The 5-day average of Advances minus Declines reached -1567 on the initial low but only -1062 on the retest.
At today’s close the 5-day average of Advances minus Declines reached -1641 so it is clearly way overdone. During this high energy decline the S&P 500 has lost -12.2% in only 6 trading days which is comparable to the prior declines just reviewed. The news is not going to get materially better even though a sharp rebound in the S&P 500 is possible. Additional selling is likely on Friday since who wants to be long going into this weekend when the news could get even uglier.
Many important lows have occurred during a big decline after a decline on a Monday and down opening on Tuesday, which leads to a reversal higher. If the current decline follows the pattern, a retest is likely 2 – 4 weeks after the initial low. If the 5-day average of Advances minus Declines is comfortably above the extreme level recorded at the initial low on the retest, a sustainable rally can develop. Clearly, we’re not there yet.
The number of stocks making a new 52-week low can also provide some insight. On the initial price low the number of 52-week lows soars and then shrinks during the retest. In 3 of the past 4 important lows in the past 5 years, the number of new lows jumped to well over 1,000. Today the number of new lows was 696 so it can increase in the next 2-3 days possibly over 1,000, if the initial low is hit by next Tuesday.
In 2015 China stabilized its currency after the devaluation which also stabilized the stock market. In early 2016, oil prices bottomed and then firmed up after plunging from over $100 a barrel to less than $30. As oil prices rallied, the stock market rallied.
The decline in January 2018 was ignited after wage growth jumped and raised concerns about the Federal Reserve hiking interest rates. Investors calmed down after realizing that better wage growth would be good for the economy and corporate earnings.
The big decline in the fourth quarter of 2018 was driven by fear that the Federal Reserve would keep increasing rates in 2019 after hiking them in December 2018. These fears were quelled after Jay Powell assured the markets that the Fed would not raise rates in 2019 on January 3, which was enough to prevent a retest of the low on December 24.
The FOMC is likely to lower rates, possibly at the March 18 meeting, but it isn’t likely to have the same impact as Powell’s 180 degree reversal in January 2018. The stock market will greet any rate cut with a rally, but soon realize that lower rates won’t provide a vaccine or make people comfortable enough to go to a movie, sporting event, the shopping mall, or increase the number of Chinese workers returning to work.
The fact that there are no policy options that can directly solve the problem of COVID-19 does heighten the risk that the S&P 500 could continue to fall, if more infections occur in the U.S. and increase the probability of a recession. As I noted in the January Macro Tides, the stock market was priced for perfection and not disappointment, and this could prove to be far worse than a disappointment.
Imagine if the March Madness Tournament was called off out of concern infections could soar, or the major league baseball season was delayed. If investors become convinced that a recession is likely, the S&P 500 could drop to 2500 or 2347. As noted at the beginning, if COVID-19 becomes a global pandemic and meaningfully invades the U.S., there are no support levels until selling dries up or the virus fades as temperatures rise.
I attempted to buy 3M asbestos masks this morning for my wife and myself at Home Depot and Lowes, only to learn there were no masks within 100 miles. I then ordered them on Amazon. When I attempted to buy two more for friends 3 hours later, there weren’t any to be found. It won’t take much in coming days to get millions of Americans to change their behavior as they hear about the decline in the stock market, and watch the evening news about the coming pandemic.
Disclosure
The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index. The Nasdaq 100 is composed of the 100 largest, most actively traded U.S. companies listed on the Nasdaq stock exchange. All indices, S&P 500, Russell 2000, and Nasdaq 100, are unmanaged and investors cannot invest directly into an index.
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