The volatility we’ve seen in stocks in the past week is merely the latest permutation of selling that’s hit pretty much every other asset class since mid-year. Trickle-down selling, if you will.
It started with commodities, which have been slammed by a breakout in the U.S. dollar (up nearly 7 percent heading into the end of the quarter). It spread to areas like emerging market and European stocks.
Lately, it’s been focused in high-yield junk corporate bonds, which just suffered their worst weekly decline since June of last year.
And now, it’s hitting stocks, with the iShares Total Market (ITOT) pawing its 50-day moving average, though it touched its 75-day average Thursday (purple line in the chart). As you can see in the chart, in about six mini-corrections over the past two years, that’s all that was needed to provide the pause that refreshes. In four others, a decline to the 125-day average was needed (red line). In every case, that was it, though: No monumental smackdowns.
As a result, a decline of around 2.3 percent from here would be the fence that bears would have to jump in order to start to make experienced investors more worried.
Bears have been making more progress than casually meets the eye, however. You can see it in the breadth measures, which suggests that much of the market has been idling or stuttering in a 5 mph reverse since July.
Indeed, you should know that half of the Russell 2000 stocks fell into a bear market (down 20 percent or more from their highs) back in May while half of the Nasdaq Composite fell into a bear market earlier this month. It’s like an undetected cancer: Spreading slowly and silently, but relentlessly. It is stoppable, though, with the right treatment and some good luck.
The best way to visualize where we are is to look at the NYSE Composite, which peaked just before the July 4 holiday weekend, then failed in a retest of that high at the beginning of September, and is now sliding lower.
What about the mega-cap indices like the Dow? They are being held higher by a narrowing group of strong performers such as DuPont (DD) and Nike (NKE) while a growing list of Dow components like American Express (AXP), Chevron (CVX), and Caterpillar (CAT) roll down through their 200-day moving averages.
In short, lots of crosscurrents. If you’re going to be long stocks, you need to be in the right groups like health care, transportation and tech; avoid commodities, emerging markets, the euro zone and small caps; and even start to be a little wary of mid-caps. Remain vigilant on value, but be aware that the market is paying up for growth right now because it does not see a lot.
Why is this happening?
Well, the obvious answer is that investors are growing nervous over the approaching ending of the QE3 bond purchase program. Since the bull market started, stocks have done well when the Fed is injecting tens of billions into the fixed-income market each month, bolstering stocks by encouraging debt-funded corporate buybacks.
When the Fed has bowed out, like it was after the end of the QE1 and QE2 programs, stocks suffered. Of course this is well advertised; everyone knows it is coming; but it can still, oddly enough, come as a surprise.
What makes this time different is not only is QE3 about to end, but its termination is being mixed with growing awareness that we’re moving ever closer to the Fed’s first short-term interest rate hike since 2006. That’s why the high-yield junk bond market has been so weak lately.
It’s also worth highlighting the weakness happening overseas in places like Europe and China in response to poor economic results.
The iShares Europe 350 (IEV) is down 8 percent from its high set in June while the iShares China (FXI) is down 8 percent from its early September high.
Economic weakness in the euro zone and China is pulling down commodities. But so is the surge in the dollar. The buck has broken a long-term resistance line going back to 2005 by rising 11 weeks in a row, and has only suffered three weekly declines since April. The strength is being driven by a combination of U.S. economic strength, foreign weakness, U.S. stock market outperformance, a hawkish turn of U.S. monetary policy relative to the rest of the world, and American military prowess.
There are pros and cons here. U.S. consumers will benefit from lower energy prices, with crude oil already testing down to early 2013 levels. And lower import prices will keep inflation down, giving the Fed time to wait on rate hikes.
But there are risks here as well. Lower inflation could worsen into outright deflationary pressures, which will put the Fed in an awkward spot. And the dollar’s strength has been offset by big weakness in the Japanese yen that threatens to get unruly. It was a dramatic pullback in the Japanese yen that set off the Asian Contagion financial crisis of the 1990s.
The final takeaway is this: While currencies, commodities and the machinations of foreign markets are interesting and sometimes even relevant, in the end, what matters is whether the bulls here at home can turn around eroding breadth measures and halt this bout of market weakness. If they can’t, bears will emerge from hibernation and push the market down into the first 10 percent-plus correction since 2011. Watch the purple line in the iTOT chart; a decline below that level would mark the switch of power to bears.
To apply a baseball metaphor on the eve of the MLB playoffs, bulls are in the batter’s box with two outs and the potential tying and winning runs on base. They can be heroes or goats with the next swing of the bat. I still think they will come through with the grace and skill under pressure of Derek Jeter in his prime. But at the same time, beware of the potential to ground into a game-ending double play.
On Thursday last week, Apple (AAPL) sank below its 50-day average for the first time in four months following its botched iOS8 rollout and the iPhone 6 Plus “bendgate” controversy.
The company will survive these embarrassments, and so will the stock. Despite my over-expressed disappointment with Apple, one cannot ignore the fact that the shares are undervalued. Indeed they are actually in a sweet spot in which they can be bought by both growth and value managers.
Indeed, I am now going to exercise restraint and not gloat about Apple’s self-inflicted wounds because one of our longtime readers wrote in to say that I had become a broken record about my disdain for the Cupertino colossus. He said:
“I have been a long time subscriber and have enjoyed your comments over the years, but your obsession with AAPL is getting annoying. It’s like the Eveready bunny. It keeps going and going. I respect your opinion, but I do not believe that being so one-sided is healthy for subscribers. Listen, I get it. You just don’t like the iPhone, fine, now let’s talk about the bigger picture and move on.
“Personally, I have experienced both the Android and iPhone platform and both have their place. It’s a waste of energy to debate which phone is better because really it comes down to what works for you. As you well know, the best technology does not always win.
“Apple is all about an “ecosystem”, for better or worse, and they do a better job at making money per phone user than any other phone platform. That is a fact. Will that continue? Hard to say, but here in the U.S. they will continue to leverage their ecosystem and make money. As an investor, that is all I care about. I have owned GOOG and AAPL for many years and each has been profitable.”
I answered by stating that there used to be an ecosystem when you were locked into using the songs you bought through iTunes through the Apple interface. However, since everything you need is now in the cloud — you stream music from Spotify on any kind of device, and your Gmail and maps are on any device, and your Word documents can open on any device — what exactly is the ecosystem? No one needs to stay in the Apple compound.
In other words, once you go cloud, you are freed of the ecosystem, you are unchained. And Apple is going to have a hard time keeping people locked down. But what Apple has going for it is consumer inertia and fashion. People want to show that they are part of the Apple tribe even if there is no real advantage.
The subscriber wrote back: “For the younger generation you are right, they are less loyal and more likely to seek out freedom of choice. Hence, an open system is an alternative. But the older generation prefers the path of least frustration, which makes the ecosystem so easy. Get them hooked, and like the horse that is led to water they will drink.
“Granted you and I understand the cloud/ecosystem and the abundance of choice, but most people of all ages prefer to be led to water and be told to drink. It is about human behavior i.e., the perception that Apple has been, and will continue to be easier and safer than other choices. I guess we will see.”
I actually think that this is an important debate — closed vs. open systems, and which is more profitable to which companies. Personally I feel that you should never bet against freedom, and the world of software is headed inexorably in that direction. Apple can still win in the open ecosystem world, but it will have to do so in a new way. I think that their new preference for hiring executives from the fashion world is a step in that direction.
Consider the humble wristwatch, which is essentially an open system. You could buy a $15 Timex or a $15,000 Breitling and they both perform exactly the same technological function by telling time. So why is there such a gulf in the value of the object? It’s fashion, obviously. So Apple wants to be the Breitling, or at least a more affordable Breitling. To do that they need to employ marketing to convince people that their products are somewhat exclusive and super-cool. They’re doing that. Can it persist? Probably but it’s not as much of a lock now as it was three to five years ago before the emergence of mobility and the cloud.
Reminds me of the bakery that burned down. Now its business is toast.
See, I can be open-minded. Let me know what you think in the comment section below.