U.S. equities were hit hard on Thursday, with the major averages on the cusp of breaking their seven-week-plus uptrends.
In the end, the Dow Jones Industrial Average lost 1%, the S&P 500 Index dropped 1.2%, the Nasdaq Composite fell 1.5% and the Russell 2000 lost 1.5%. Treasury bonds rallied nicely on safe haven inflows, gold gained 1.5% and crude oil lost 0.9% as Wednesday’s inventory-driven surge faded.
There were a number of catalysts in play.
For one, normally dovish Chicago Federal Reserve President Charles Evans raised expectations of two rate hikes this year (vs. market expectations for just one). Regulatory worries remain acute as the White House clamps down on corporate tax inversions, dampening M&A activity. European bank stocks were under pressure on fears over rates cuts deeper into negative territory. And Japan was also suffering as the yen carry trade — represented by the ProShares UltraShort Yen (NYSEARCA:YCS) below — as Prime Minister Abe and the Bank of Japan look increasingly toothless to reinvigorate the Japanese economy.
All of this is bad news for financial stocks, which suffered some big breakdowns. Negative interest rates squeeze profit margins and weigh on the already vulnerable Eurozone banks. The Fed becoming more aggressive with its rate hikes could effectively destabilize global markets and threaten currency valuations.
Financials lost 1.9% to lead the decliners. Morgan Stanley (NYSE:MS) lost 2.9% to drop below its three-month consolidation range and put its February low back in play. The lifted the April $24 MS puts recommended to Edge Pro subscribers on March 30 to a gain of nearly 220%.
EBay Inc (NASDAQ:EBAY) lost 5.2% after ChannelAdvisor data showed March comp sales down 0.2% over last year vs. a 10% rise in February. Pacific Sunwear of California, Inc. (NASDAQ:PSUN) lost nearly 40% after filing for Chapter 11 bankruptcy protection.
After seven weeks in which the bulls pretty much had it all their own way — capped by last week’s super-dovish speech by Federal Reserve Board Chair Janet Yellen — folks are coming back to reality as the start of the first-quarter earnings season looms on April 11.
Analysts are looking for S&P 500 earnings to decline 8.5% over last year — on track for the fourth consecutive quarter of falling profitability. Corporate profits peaked in the second quarter of 2015. Recessions typical start five to seven quarters afterward.
The current economic expansion is looking old and feeble, with the Atlanta Fed’s GDPNow tracking estimate of first-quarter growth recently being cut to just 0.4% and the Federal Reserve admitting that despite strong job gains they don’t feel confident enough to raise rates again. Factory activity remains tepid, with new orders and shipments on the decline since late 2014.
The technical and fundamental outlook still looks challenging for stocks as the Dow Jones Industrial Average contends with major overhead resistance near the 18,000 level.
The price-to-sales ratio of U.S. stocks hasn’t been higher since the sub-prime bubble blew. Debt-funded corporate stock buybacks — a major source of buying demand for equities — look vulnerable as buybacks as a percentage of operating income has reached a record high. Net debt-to-equity ratios have jumped their historic range as balance sheet leverage amps up.
Strategists from JPMorgan warned clients this week to brace for the end of the seven-year bull market: “This is not the stage of the U.S. cycle when one should be buying stocks with a six- to 12-month horizon. We recommend using any strength as a selling opportunity.”
I couldn’t agree more and have recommended defensive positions, such as the VelocityShares 2x VIX (NASDAQ:TVIX) which gained 16.4% for Edge subscribers today, in anticipation of further market weakness.
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.
