Pressure Points to Look for in Stocks This Week
It's not a real market event unless it gets a name, such as the Taper Tantrum or Black (fill in the day of the week). So let me be the first to suggest the February Freakout of 2018. Freaky Friday? But the real action started a week ago, on the following Monday, when the Dow Jones Industrial Average dropped nearly 1,200 points -- one of the biggest point drops in history, though on a percentage basis was only a fifth of 1987's Black Monday. So Gray Monday? Although the Volatility Crunch might be more descriptive of what transpired. However, if the market continues its rebound from Friday, when the Dow gained more than 330 points, we're not going to need a name because few investors will remember the last week and a half as much more than a passing rumble.
What we have heard more than enough since this sell-off began was to have perspective. Many have tweeted that the tumble puts us all the way back to where stocks were in December, noting that the market is still up in the past year and a half, let alone eight. The Wall Street Journal said it's not the market that is being tested, it's us. The New York Times said the drop was long overdue and is just a return to more normal markets. Feel better? We've been bit by the perspective bug here at Gadfly as well, saying that despite the sell-off stocks are still historically expensive. If you liked stocks before, there was no reason not to like them now, and vice versa. Not much has changed.
All that is good advice, but too much perspective could keep investors from learning anything from the market's recent $3 trillion tumble. The U.S. has a president who seems intent on focusing his attention and policies on a market he does not fully understand; an economy that has been running hot, with little inflation, for a while; and a central bank just itching to raise interest rates. It might be nice for investors to put up 100-year stock charts to reassure themselves that the market rises over a long horizon.
But investors might want to take a hard look at the chart of the stock market of the past week because they might be in for more of that. Yes, as the New York Times points out, only a small sliver of the American population has most of their net worth in the market. But those are the people with the money. And how they react to market volatility will shape how much of the sell-off creates a feedback loop in the economy, and how much it matters. But it won't be a while until we know that. In the meantime, here are some factors that could indicate where stocks are headed:
Right now, the trend is probably not investors' best friend. One of the best indicators of what stocks will do in the very short term is what they have been doing recently, which is mostly dropping. Technical strategists like to talk about moving averages, and we nearly crossed a big one on Friday -- the 200-day moving average -- before bouncing back. Resistance, which is what a bounce-back is called, is good in technical analysis. But retesting a low is bad. The number to watch is 2,539 on the S&P 500 Index, which is still 80 points bellow where the market average closed on Friday. Go through that, and technical strategists will tell you it's time to worry, even if the rest of us are still trying to tell you not to.
Bond yields are something to keep an eye on. Rising interest rates, and the fact that they might be signaling higher inflation, are seen as a trigger of the current troubles. Rising interest rates are bad for stocks, particularly if they are rising as the market is plunging. But rates have leveled off in the past week. In fact, in the past week, a pretty good indication of the direction of stocks has been the direction, inversely, of the 10-year Treasury. Still, bonds would have to rise a lot more to be truly dangerous to stocks. The S&P 500's earnings yield, which is the inverse of the price-earning ratio and is analogous to bond rates, is around 6, or still more than double the 10-year's 2.8 percent. Other bonds, though, are getting closer to be in striking distance. The closer they get, the worse off stocks will be.
One of the biggest reason stocks have done well in the past year, even more so than the U.S. tax cuts, has been the resurgence of the global economy. But oil prices, often one of the best gauges of global growth, have been flagging recently. Investors haven't made too big a deal of that yet, perhaps because of everything else going on, but they could soon. After rising for much of the past year, oil prices have dropped in the past month before ticking up on Monday. The decline could be a factor of rising supply and the growth of fracking in the U.S. But a continued slump in oil could signify that the global economy, and the stock market by extension, is not on as solid footing as people think.
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Daniel Niemi at firstname.lastname@example.org