Since the middle of October, things were quiet. Too quiet. The S&P 500 spent 29 consecutive days above its five-day moving average. And November marked the 29th consecutive month the S&P 500, on a monthly basis, closed above its five-month moving average.
Nothing like this has ever been seen before in market history. Not even close. And that pushed investors to take on more risk, push cash levels to new lows, and boost measures of sentiment to new extreme. No wonder, given that December has historically been the best performing month of the year for stocks.
But change is afoot. In fact, stocks appear to have tipped into a new downtrend for the first time since September — setting the stage for volatility and weakness in the weeks to come. This after the Dow Jones Industrial Average lost 0.3%, the S&P 500 lost 0.7%, the Nasdaq Composite lost 1.3%, and the Russell 2000 lost 1.6%.
Transportation stocks dropped 2.7% in what was the worst one-day drop in 10 months.
The main catalyst was last Thursday’s decision by OPEC to hold production near current levels, oversupplying the market in a cold-blooded bid to pressure the U.S. shale oil industry and recapture market share. Crude oil has been crushed to five-year lows near $65 a barrel, pulling down the entire energy sector on fears that with a growing share of shale production profitable, bond defaults and bankruptcies will follow.
The selling pressure is continuing on Monday after weaker-than-expected Black Friday sales and a series of disappointing reports on global manufacturing activity. The JPMorgan Global PMI has dropped to 15-month lows with U.S. factories suffering too, unable to keep ignoring the slowdowns underway in Asia and Europe. German factory activity dropped to a 17-month low and contracted on a month-over-month basis for the first time since 2013.
The selling pressure that has been bottled up since the middle of October is being unleashed. You could see this in the flash crash that hit Apple Inc. (AAPL), which on account of its persistent rise and huge market capitalization nearly single-handedly forced the market higher over the last two months. The tech giant dropped nearly 6.5% before finishing with a 3.3% loss.
This is a sign of fragility, that the situation is so high strung that a wave of selling orders could result in disorderly price action.
You can see the change in the way the NYSE Composite Index, my preferred measure of the stock market, has made a downward cross below its 20-day moving average for the first time since September as it forms a possible triple-top pattern. You can see the change in the way market breadth, or the number of stocks moving to the downside versus to the upside on Monday, has dropped to levels not seen since early October as investors rush for the exit. You can see the change in the way the relationship between stocks and Treasury bonds, a sign of risk appetite, is dropping in a way not seen since late September.
If December does turn into a dud, it’ll come as a surprise to many. Historically, December is the best single month for the S&P 500 averaging a gain of 1.7% since 1950. And if it does turn lower, it could spell big trouble for what lies ahead in 2015. According to Jeff Hirsch of the Stock Trader’s Almanac, a precipitous market decline in December is a rare event. But when it happens, “it is usually a turning point in the market — near a top or bottom.”
And of course, now that the calendar has flipped into December, Wall Street is confronting the potential for another fiscal fight in Washington with a budget deadline looming on Dec. 11 and Republicans itching or a fight after President Obama’s executive action on immigration. The debt ceiling looms in March.
If that wasn’t enough, the specter of rate hikes from the Federal Reserve will come back into focus starting with Friday’s jobs report and a policy meeting later this month.
In response, I’m recommending subscribers seek out areas of weakness in stocks like Bank of America Corp (BAC), which is dropping out of a three-month topping pattern on fears that an increase in energy sector defaults will hit bank loan books. The December $17 puts I recommended to Edge Pro clients on Friday are already up more than 80%.
For the more conservative, consider raising cash or increasing your allocation to Treasury bonds.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.
