What a difference a week makes. Last Friday, stocks surged in response to a slightly-better-than-expected November payroll report that seemed to confirm that the Federal Reserve would indeed raise interest rates this month for the first time in nearly a decade.
But this Friday, stocks suffered mightily, in what was the worst one-day decline for large-cap stocks since September.
This, as investors reacted to ongoing declines in crude oil prices and high-yield bonds. Treasury bonds also rallied, breaking out of a trading range going back to August, as fears grow that the Fed could be on the verge of a policy mistake amid recent slowdowns in U.S. factory activity and other economic measures.
Adding to the pressure were big declines in popular Big Tech momentum favorites such as Amazon.com, Inc. (NASDAQ:AMZN) and Facebook Inc (NASDAQ:FB).
In the end, the Dow Jones Industrial Average lost 1.8%, the S&P 500 Index dropped 1.9%, the Nasdaq Composite shed 2.2% and the Russell 2000 closed 2.2% lower. The dollar weakened, gold gained 0.4% and oil fell 3.5% to $35.47 a barrel — returning to 2008/2009 lows — down 11.3% for the week.
Oil prices continue to wilt in the wake of last Friday’s decision by OPEC to hold production near current levels of around 31.5 million barrels per day. Today, inventory concerns were in the forefront after the International Energy Agency said the global supply surplus could persist until at least late 2016 as Iranian crude comes back into the market.
It also highlighted OPEC’s “renewed determination” to squeeze weaker, high-cost non-OPEC producers in a bid to regain market share from U.S. shale producers.
Corporate credit was hit after Third Avenue Management’s junk-bond fund barred investor withdrawals while it liquidates — attracting attention the long simmering problem of ultra-low trading volumes in many areas of the corporate bond market after years of near-zero interest rates from the Fed.
Management highlight difficult market conditions, made worse by hedge fund short positions, making it nearly impossible to raise cash to meet redemption requests without liquidating positions at fire sale prices. Reuters reported that at least one-fifth of the fund’s assets were in illiquid positions.
As a result, the iShares High Yield Corporate Bond Fund ETF (NYSEARCA:HYG) fell to levels not seen since 2013 and suffered a 3.8% decline for the week, its worst performance since 2011.
All of this further raises the stakes for next week’s Federal Reserve policy decision since the start of a policy tightening campaign will only further encourage investors to sell high-yield bond positions on yield sensitivity and rising default risks out of the energy sector amid fresh declines in crude oil.
No surprise then that energy stocks led the decliners, falling 3.4% as a group followed by material stocks, which dropped 2.7%. Exxon Mobil Corporation (NYSE:XOM) lost 1.8% while Chevron Corporation (NYSE:CVX) lost 3.2%, boosting the value of the Dec $86 puts recommended to Edge Pro subscribers.
Friday’s large-cap breakdown only confirmed weeks of warning from areas like transportation stocks, small-cap stocks, utility stocks, commodities, and credit. All of which have been weakening for a while now. It also confirmed technical signs something was amiss, such as oddly weak market breadth measures as fewer and fewer stocks held the major averages aloft.
That’s all changing now, as investors realize the end of the Fed’s 0% interest rate policy won’t be as benign as they hoped.
OPEC’s price war is bad news for inflation returning to the Fed’s 2% target and its bad news for overall corporate earnings growth as energy sector revenues get smashed.
Rising deflation fears and safe haven bids in Treasury bonds, as well as overall financial market turbulence, is bad news for financial sector earnings as trading revenues are sure to be hit and net interest margins pinched.
And credit market pressures reveal that once again, many “reached for yield” in a ultra-easy Fed policy environment and are now set to get their hands caught in the cookie jar as rates move higher and liquidity dries up. This time, it’s all about high-yield junk bonds (especially those related to U.S. shale oil plays); last time, it was those subprime mortgage-backed securities.
In response, I continue to recommend defensive positions to my subscribers including the VelocityShares 2x VIX (NASDAQ:TVIX) that is up nearly 60% so far this month for Edge subscribers as options traders seek put option protection against further market losses, pushing up premiums.
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.
