Morning Comment: More Holes in the Dike (Think Italy)

The S&P 500 has fallen almost 5% over the past two days and the DJIA has lost over 1,200 points, but after a 28% rally in less than a month, these are not the kind of numbers that will scare many people. We’re going to have to see more downside follow-through going forward before anybody will raise another warning flag.

The decline over the past two days has not come on rising volume, so that’s a plus. (The volume has been in-line with what we’ve seen over the past week and a half…except for Friday, which was an expiration day.)…….The breadth numbers were quite interesting yesterday. It was just 4.4 to 1 negative for the NYSE Composite index and 2.8 to 1 negative for the Nasdaq Composite. However, it was 16 to 1 negative for the S&P 500 Index…and 33 to 1 negative for the NDX Nasdaq 100 Index!

Needless to say, that outsized number in the NDX was a reflection of the sizeable pull-back in the tech stocks yesterday….as the XLK tech ETF fell 4.1% and the SMH semiconductor ETF dropped 4.5%. The tech group held-up quite well during the February/March crash, so the fact that it is beginning to underperform is a concern. HOWEVER, one day does not make a trend, so we are a long way from raising any kind of warning flag on this all-important leadership group. It’s just that a small number of big-cap tech names have led the multi-week bounce-back in the broad market, so if (repeat, IF) yesterday’s underperformance in tech does indeed continue, it will definitely create some more concerns about the broad stock market.

In our piece yesterday morning, we talked about how the action in the oil markets was another in a series of examples where several different markets have seen periods of pronounced volatility. This actually started before the coronavirus outbreak…when the repo market fell under considerable duress last fall…but it has obviously spilled over into many different markets more recently. This kind of wild action…in so many different markets…is not a good development at all in our humble opinion.

There is yet another area where we are seeing some outsized moves in the global markets. This involves the CDS prices for Italy’s sovereign debt. These CDS prices (which measure the cost of buying insurance on Italy’s sovereign debt) are now back up to the same level they saw when the global stock markets were melting down in March. We all know how hard Italy has been hit by the coronavirus, so it’s not a big surprise that they’re seeing some visible stress in their markets. However we’d also note that the Italian bank index is now trading at its lows for the year…and is down almost 50% since its February highs. When you combine this with the fact that the broader STOXX Europe 600 Banks Index also made a new low yesterday…and it shows that we have another spot where we could see a hole in the dike spring a leak going forward. (Three charts attached below.)

The reason why this is such a concern is that whenever you get a major decline in a single market…one that would be considered more than just a correction…it always seems to induce a major blow-up in somebody’s derivative positions. When we see SEVERAL different markets experience major blow-ups, it becomes even MORE LIKELY that somebody is sitting on some serious losses. Those losses don’t always become evident immediately, but it usually doesn’t take very long either. So we believe that investors need to tread lightly going forward.

We can’t believe we’ve gone this far without mentioning the price of oil, but we’re guessing you already know that the action in crude yesterday (and this morning) has not calmed any nerves after Monday’s historic action. The action in crude since Monday shows that the decline in this economically sensitive asset class was not just technical in nature…and thus it’s something we have to pay attention to as we try to determine how the economy will respond once the lock-down restrictions start to come-off.

Don’t get us wrong, once demand picks back up (which it will…at least to some degree)…and the storage capacity for crude opens up again, oil prices will certainly bounce. However, we’re quickly learning by these developments (and the moves in other markets…like the Treasury market), that the economy’s decline has been deeper than a lot of people realize…and thus it might not bounce-back as quickly or strongly as the stock market had been pricing-in over the past few weeks.

When it really comes down to it, nobody has a clue how strong the economy is going to be in 2021…or how much earnings will bounce-back next year. It’s a complete guessing game. Right now, investors are buying stocks at levels that cannot be considered cheap for the broad market for two reasons. One is the hope that the global economy will bounce-back strongly…and the second one is the belief that the Fed will push asset prices higher going forward…just like they did in the years following the financial crisis.

Our concerns about this kind of thinking are three-fold. First, “hope” is not an investment strategy. Second, the goal for the Fed might merely be to provide a safety net for the markets and the economy…and not necessarily to push asset prices higher this time around. Third, and most importantly, history tells us that whenever we have a recession to go along with a bear market, there are several waves of selling that take place…and the Fed has to come back several times with new plans before a long-term bottom for stocks is put in place. (Yes, the first program is usually seen as unprecedented…just like this one has been…but it’s usually not enough.) There are almost always several waves of selling…after it becomes evident that highly leveraged investors and highly leveraged companies have encountered much larger problems than people realized after the first wave of selling took place. Thus the Fed usually has to come back and with a series of programs…even though the first one was quite large.

This is why we continue to believe that investors should avoid chasing the stock market at these levels. Let the market come to you.

Matthew J. Maley

Managing Director

Chief Market Strategist

Miller Tabak + Co., LLC

Founder, The Maley Report

275 Grove St. Suite 2-400

Newton, MA 02466


Although the information contained in this report (not including disclosures contained herein) has been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. This report is for informational purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security. Any recommendation contained in this report may not be appropriate for all investors. Trading options is not suitable for all investors and may involve risk of loss. Additional information is available upon request or by contacting us at Miller Tabak + Co., LLC, 200 Park Ave. Suite 1700, New York, NY 10166.

Posted to The Maley Report on Apr 22, 2020 — 8:04 AM
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