Expect the Market to Get Even More Extreme

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U.S. equities were hit hard on Monday. The catalyst: The reappearance of the euro zone debt crisis adding to an already long list of worries.

But it could have been much worse. After being down as much as 2.5% intraday, the Dow Jones Industrial Average managed to scrape back above the psychologically important 16,000 level, closing down 1.1%. The S&P 500 lost 1.4%, the Nasdaq Composite fell 1.8%, and the Russell 2000 was down 1.7%.

Treasury bonds strengthened (yields fell), and the U.S. dollar weakened. Gold surged 3.5% for the best one-day gain since December 2014, and crude oil for March delivery lost 3.9% at $29.89 a barrel.

Breadth was heavily negative, with decliners leading advancers 2,524 to 646 on the NYSE, and down volume accounting for 81% of the total.

The small-cap Russell 2000 led Monday’s decline, showing a loss of more than 3% at the day’s lows, and closing at a level not seen since the summer of 2013.

Recent momentum favorites, especially in the technology sector, were hit hard. Amazon.com, Inc. (AMZN) lost 2.8% while Facebook Inc (FB) dropped 4.2%.

Unfortunately, this doesn’t look like a typical bull market pullback. It has all the hallmarks of something much worse.

Dow Jones Industrial Average Chart

Turning to Europe, political risk has popped back up. Greek bailout negotiations have stalled and Spain has no government.

The stress is manifesting in more obscure areas of the European debt market, with a focus on Deutsche Bank AG (USA) (DB) in particular, after poor earnings results raised questions about its capital position. The value of contingent convertible or “CoCo” bonds plummeted (on fears of conversion into equity), while the value of its credit default swaps (a measure of fear) soared to levels last seen in 2011.

This is just the latest wrinkle bothering investors, added to a list that already includes low oil prices, stalled corporate earnings growth, weak U.S. economic data, troubles in China and the specter of rate hikes from the Federal Reserve.

A downward spiral is developing. Reports are claiming Chesapeake Energy Corporation (CHK) hired bankruptcy lawyers. Fears of shale energy bond defaults pushed the SPDR Barclays Capital High Yield Bnd ETF (JNK) to a multiyear low while bank proxy Select Sector Financial Slct Str SPDR Fd (XLF) is at risk of losing its 200-day moving average for the first time since 2012.

Safe havens are few and far between. Treasury bonds are rallying, but carry a negative real interest rate. But gold appears ready to emerge from its downtrend that began in 2012. For investors with the ability to tolerate risk, precious metals stocks look like the best choice, since valuations have been bombed out.

GDX Chart

Edge subscribers are enjoying a 46% month-to-date gain in Kinross Gold Corporation (USA) (KGC) and a 28% gain in Goldcorp Inc. (USA) (GG). And Edge Pro subscribers are sitting on a 425% gain in their February $105 calls on SPDR Gold Trust (ETF) (GLD).

Further gains for gold and silver look likely this week as Federal Reserve Chair Janet Yellen gives her semi-annual monetary policy testimony to Congress starting on Wednesday. She is expected to talk up rising risks to the Fed’s inflation outlook (which remains below the 2% target) as a result of market volatility tightening financial conditions. This should push expectations of a rate hike back until the second half of 2016 or early 2017.

Until economic data revs back up, oil prices stabilize and bond markets settle down, stocks will probably continue to drift lower. Much depends on what the Fed does from here, since it has the power to set this downward spiral in reverse — pushing down the dollar and helping lift oil prices, earnings growth and, thus, stock prices.

TLT Chart

The Nasdaq Composite is now down 15% in less than 30 trading days, marking one of the hardest and fastest declines on record from a 52-week high. According to SentimenTrader, there have been seven other pullbacks of this magnitude since 1978. And save for the 2000 dot-com meltdown, all gave way to nice medium-term rebound rallies.

Sentiment is also looking better. Small speculators — the so-called “dumb money” traders — have ramped up their short bets against stocks after dumping the long positions they built up as the market topped in the middle of December.

And breadth has improved with less than 8% of the stocks in the Nasdaq Composite following the index down to a new 52-week low on Monday versus a high of 30% on Jan. 20. Similar behavior was seen in early 2008, which was a horrible time to be buying stocks, but also in late 2008, which was a great time to buy and hold.

Long story short, we’re either primed for a nice oversold rebound rally or a 2008-style waterfall collapse. Extremes are building up, making the outcome binary. We’re likely to see the major indices move 5% or more in the days to come, whether up or down, rather than quiet 1% or 2% moves, as critical technical support levels are tested.

Remain cautious.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

Anthony Mirhaydari is the 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.


Article printed from InvestorPlace Media, https://investorplace.com/2016/02/expect-the-market-to-get-even-more-extreme/.

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