It was a wild ride for U.S. markets on Wednesday after global equities — as measured by the MSCI World Index — dropped 20% from its early-2015 record high.
At the day’s low, the Dow Jones Industrial Average was off more than 500 points on concerns over fresh weakness in crude oil, a lack of rate cuts by the Bank of Canada and weak economic data out of China, along with indications policymakers in Beijing could be shying away from a new interest rate cut.
But a powerful afternoon rebound (led by heavily shorted small-cap stocks that have been hit hardest in the recent selloff) trimmed much of the losses. The result has all the hallmarks of a classic “dead-cat” rebound rally that should last a week or two before the selling reemerges.
In the end, the Dow Jones Industrial Average lost 1.5%, the S&P 500 lost 1.2%, the Nasdaq Composite lost 0.1% and the Russell 2000 gained 0.4%. Treasury bonds were stronger, the dollar was little changed, gold gained 1.2% on safe haven inflows and oil dropped nearly 6% to close at $26.76 a barrel.
The late day rally lifted the iShares Russell 2000 position recommended to Edge subscribers to a gain of 3.4% after being recommended last night for purchase this morning. The gold rally lifted their Market Vectors Gold Miners ETF (NYSEARCA:GDX) by 3.1%.
The drop in crude oil was the largest one-day slide since September as investors continue to worry about the impact the influx of Iranian crude oil will have on an already oversupplied market now that economic sanctions are being lifted as part of the nuclear energy deal. The weakness continued after the close after the API inventory report showed stockpiles grew nearly double what was expected (4.5 million barrels vs. 2.3 million expected).
Reuters highlighted analyst estimates showing that about 50 listed U.S. oil producers need oil near $40 a barrel to break even. With bond rates higher as junk bond prices weaken, it’ll be near impossible for these companies to refinance short-term debt as fears of defaults and bankruptcies rise. Which is exactly what OPEC wants as it continues its price war against U.S. shale producers.
No surprise then that energy stocks led the decliners, off 2.9%. International Business Machines Corp. (NYSE:IBM) lost 4.9% after reporting in-line fourth-quarter revenues and an earnings per share beat, but it was low quality reliant upon lower taxes and was spiked by weak forward guidance. Beleaguered chipmaker Advanced Micro Devices, Inc. (NASDAQ:AMD) lost 4.9% after reporting results in line with expectations by issuing lower-than-expected revenue guidance on a lack of growth catalysts.
Netflix, Inc. (NASDAQ:NFLX) closed with a 0.1% loss, after trading down more than 10% earlier in the session, after reporting better-than-expected subscribers adds thanks to its international business (domestic was weak). Twitter Inc (NYSE:TWTR) gained 4.1% on acquisition rumors.
Technically, however, this looks like the last gasp of the current short-term downtrend — setting the stage for a powerful short-covering rebound rally over the next week or two. With sentiment so bombed out, it won’t take much to get the bulls to stampede:
- A comment by a Federal Reserve official worried about financial market conditions (as they did back in September) and the drag on inflation from cheap oil
- Hints of oil production cuts by OPEC or Russia
- Hints of fresh policy easing by China, Japan, or Europe
- Or any variation of these themes
Many metrics are deep in oversold territory. The percentage of large-cap stocks in uptrends has fallen below 25%. The equity put-to-call ratio pushes higher into levels not seen since the financial crisis. And sentiment is getting bombed out.
Jason Goepfert at SentimenTrader wrote in a note to clients this weekend that the gap between rising “Smart Money” confidence vs. falling “Dumb Money” confidence had hit levels not seen since the August low.
Smart money is based on sentiment measures such as commercial hedger positions in the equity index futures market and the relationship between stocks and bonds, among others, that tend to correctly foresee market turning points. Dumb money confidence is based on the opposite, sentiment measures such as the equity-only put vs. call ratio, that tend to be poor predictors of market turning points.
Since 1999, according to Goepfert, there have been 135 other days when the gap between smart and dumb money confidence has been as high as it is now. Over the next 30 days that followed, the S&P 500 was positive 113 times (an 83 percent win rate) with a median gain of 4.4%.
The maximum decline over the next 30 days was 1.9% vs. a maximum gain of 6.9%.
In preparation, after playing the short side with positions such as the Jan $17 Bank of America Corp (NYSE:BAC) puts sold for a 515% gain on last Wednesday, I’ve recommend new positions such as the $60 February calls on Nike Inc (NYSE:NKE) to Edge Pro subscribers.
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.
