Investors suffered a wild rise on Wednesday, but you wouldn’t guess it by looking at the closing numbers.
The Dow Jones Industrial Average was unchanged, the S&P 500 gained 0.1%, the Nasdaq Composite gained 0.2% and the Russell 2000 lost 0.2%. At the lows of the day, the Dow Jones was down 277 points as the selloff in the Chinese yuan continued overnight.
Gold gained 1.4% while crude oil finished 0.5% higher. That lifted the Kinross Gold Corporation (USA) (NYSE:KGC) position recommended to Edge subscribers on Aug. 3 to a gain of 26%. Alibaba Group Holding Ltd (NYSE:BABA) lost 5.1% on disappointing revenues.
Edge Pro subscribers enjoyed big gains in a number of new put option positions against big banks as a flight into the safety of U.S. Treasury bonds pushes down yields, hitting net interest margins. The $38 Morgan Stanley (NYSE:MS) puts recommended on Tuesday gained 117% as profits were trimmed during trading.
The yuan is now down about 4% against the dollar over the last two days, with analysts suggesting that Beijing wants a total pullback of around 10% in a bid to boost export competitiveness and revive growth. Data out of the Middle Kingdom shows industrial production growing slower than expected as electricity output contracted at a 2% annual rate.
But then, as Europe closed, things dramatically turned around as if someone threw a switch. The catalyst, as it’s been so frequently over the last few years, was the promise of more stimulus from the Federal Reserve.
It was inevitable, I guess.
Time and time again, expectations of a rate liftoff have been pushed back as some new worry pushes back the day of reckoning. No wonder, then, that the S&P 500 hasn’t suffered a 10%-plus correction since 2012. Markets have been hypnotized by seemingly neverending promise of cheap money.
A day after the Dow Jones Industrial Average suffered its first “Death Cross” since 2011, New York Fed president William Dudley reassured investors in a big way; not unlike the way St. Louis Fed president James Bullard saved the market last October with talk of more stimulus.
Dudley said the Fed can “hopefully” raise rates in the near future, a big walk back from his previous comments that “liftoff is close” and “very disposed” to a September rate liftoff. He added that the drop in the Chinese currency will have big implications for global demand and for commodity prices.
Put plainly: Dudley, an influential member of the Fed’s Open Market Committee, is seemingly worried about the impact lower commodity prices will have on inflation already running persistently below the central bank’s target.
This was supported by a piece in the Wall Street Journal by Fed whisperer Jon Hilsenrath that the yuan’s decline could “complicate the Fed’s liftoff decision” highlighting the Fed’s reluctance to move on rate if inflation trends weaken.
To my ears, that sounds like a budding excuse to prolong the reign of the Fed’s zero-interest-rate policy through the end of 2015 and into early 2016. If so, stocks could very well turn tail and continue their multiyear meltup from here.
While Fed credibility would in my opinion be further damaged, policymakers could spin this as merely a response to the data dependency they have stressed for months.
On Monday, Michael Hanson at Bank of America Merrill Lynch told clients that developments in China made a September Fed liftoff call “just a little closer” by increasing the uncertainty around upcoming policy meetings. He recommended “paying close attention to upcoming speakers to see how they assess the risks to the Fed’s objectives and expected policy path” from the actions in China.
Now, the bad news: Volatility of the type we’ve seen today normally occurs within the context of a downtrend. Indeed, the last time the Dow Jones fell to this extend before rebounding was in late 2008 just before the Fed cut interest rates to 0%. And this comes as the S&P 500, as shown below, is on the verge of breaking a five-year uptrend supported by its 50-week moving average.
Moreover, market technicals remain vulnerable as breadth — or the percentage of stocks in uptrends — remains weak.
Jason Goepfert at SentimenTrader notes that the result has been an increase in the number of “split days” where there is an abundance of stocks making new 52-week highs and 52-week lows — one of the components of the much-maligned “Hindenburg Omen” technical signal.
The last two times there were a large number of split days combined with a death cross on the NYSE Composite (which happened on Tuesday) were in 2000 and 2008 with no false signals in between.
Looking at past dates with a number of split days of a similar magnitude to what we’ve seen so far this year, the occurrences were March 1968, August 1972, October 2000 and July 2006. After all four, stocks lost more than a third of their value at some point during the next two years.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. A two-week and four-week free trial offer has been extended to InvestorPlace readers.
