Investors were spooked Wednesday as the major stock averages sliced through major technical support. The Dow Jones Industrial Average lost 1.4% as it finally — after a heroic monthlong effort by the bulls to hold the line — dropped below its 50-day moving average with a thud.
Ebola in Texas, growing protests in Hong Kong, disappointing economic data and the fact we remain in a weak period of seasonality for the market all weighed on stocks.
Safe-haven utility stocks caught a bid as the rest of the market was punked. Energy stocks, which showed some promise earlier in the week, were dropped Halliburton (HAL) off 3%. Cruise and airline stocks were hit by the Ebola news, with American Airlines (AAL) down 3.1%.
But really, this was just the inevitable recognition by U.S. large-cap stocks of the problems and pressures already acknowledged by pretty much every foreign market and all other asset classes. The perfect, unblemished, dream-like uptrend the Dow has enjoyed since 2012 is now seriously in jeopardy.
To illustrate my point, just look at what’s happening with the small-cap stocks in the Russell 2000 index. It got slammed another 1.5% to close at levels not seen since November — washing away nearly a year’s worth of gains. As a result, the Russell has now lost not only its year-to-date trading range but the uptrend support line it’s held since early 2013.
Small-cap stocks are now vulnerable to the most serious pullback since 2011, which was the last time the Russell 2000 suffered the indignity of touching its 200-day moving average.
U.S. small caps aren’t alone. Foreign stocks, from Brazil to Germany to Hong Kong, have been hit and are well off of their highs. Commodities have been hit. Bonds have been hit, with high-yield junk bonds in particular.
Really, if you step back, the rally — which if you just look at the Dow seems OK — really topped back in July and has been running on fumes ever since. Breadth measures, or how many stocks are participating to the upside, corroborate this since they topped back then and have been narrowing ever since, defying the Dow’s steady rise.
To put it plainly: While regular investors believed all was right in the world, insiders were slowly but surely backing away. When the music finally stops, they’re already going to be sitting down while everyone else is going to be left without a chair.
Why will the music stop, you ask?
Well, for one, the Federal Reserve is preparing to end its QE3 bond-buying program this month which has been a clear influence on the consistent and low-volatility market rise we’ve seen since 2012. There are many reasons for this, but primarily it has been by encouraging credit-fueled growth in places like China while encouraging CEOs to repurchase shares here at home with debt-fueled buybacks. Sparing you the details, when the money stops flowing later this month, as is widely expected, the selling is likely to get worse — as it did when the Fed stopped QE1 and QE2.
Also, the global economic data has taken a turn for the worse. Just today we learned that German factory activity contracted on a month-over-month basis. China’s factories are on the verge of stalling.
Japanese consumers are struggling under the burden of higher taxes and higher food and fuel prices. Even here at home, the housing market is slowing as price gains cool and sales activity diminishes. Moreover, the pace of residential construction has dropped to mid-2011 levels.
Take all this, and mix in extended investor sentiment, extended stock valuations, record margin debt and record low mutual fund cash balances, and you have a recipe for a nasty finish to the year.
In response, I continue to recommend investors play things defensively by raising their cash allocations and watching the turmoil from the sidelines. For the more aggressive, there are plenty of opportunities for profit. Examples include the VelocityShares 2x VIX (TVIX), which is up 23% for Edge subscribers since early September as volatility has increased.
And for the traders, there are opportunities like the Ford (F) Oct $17 put options I recommended to Edge Pro subscribers back on Sept. 8, which are now up more than 372% after the company issued a profit warning and shares got slammed.
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Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.
