Stocks suffered a rare bout of weakness on Monday, with the Dow Jones Industrial Average suffering a loss greater than 0.6% for the first time in nearly 100 days. While the parabolic uptrend channel remains intact, for now, fear is definitely in the air as the CBOE Volatility Index decouples from equity prices and launches higher, up more than 23% today to close at levels not seen since last August.
In the end, the Dow Jones lost 0.7%, the S&P 500 lost 0.7%, the Nasdaq Composite lost 0.5% and the Russell 2000 lost 0.6%. Treasury bonds weakened again, pushing up the 10-year yield to 2.7% to hit early 2014 highs. This is a big deal, reflective of higher inflation expectations that threaten to badly undermine the cheap money “Goldilocks” status quo global markets have enjoyed.
Gold and crude oil fell while the dollar enjoyed a rebound.
Breadth was heavily negative, with decliners outpacing advancers by a 4.4-to-1 ratio on the NYSE. General Electric Company (NYSE:GE) was among the most actively traded, as was Twitter Inc (NYSE:TWTR), which gained 3.8% amid a 16% trough-to-peak rise over the last two days. Paper stocks led the way with a 13% gain while home builders were the laggards, down 3.1%.
Lockheed Martin Corporation (NYSE:LMT) and Seagate Technology PLC (NASDAQ:STX) gained 1.9% and 0.3%, respectively, after reporting results.
Investors backed away amid a very busy week of catalysts, including President Donald Trump’s first State of the Union speech on Tuesday, the start of Federal Reserve chairmen Janet Yellen’s last policy meeting Tuesday, Friday’s payroll report and a host of big-cap technology earnings from the likes of Apple Inc. (NASDAQ:AAPL) and Amazon.com, Inc. (NASDAQ:AMZN).
AAPL slipped 2.1% amid concerns about slowing iPhone X demand, throwing a wet blanket on the entire market on account of its huge market capitalization.
On the economic front, the big news was a drop in the personal savings rate to 2.4% from 2.5% despite steady gains in personal income — falling to the lowest level since 2005 and suggesting lingering headwinds for shoppers despite a strong job market.
Conclusion
Modest losses aside, the day’s result was the worst performance for stocks in five months. Just let that sink in. And it’s being driven by a combination of foreign exchange volatility, bond market weakness, a rollover in key momentum names like AAPL and the steady uptick in volatility expectations.
Something was bound to snap.
Just 18 trading days into the year through Friday, and the S&P 500 had already surpassed the average Wall Street strategist target of 2,854 for year-end 2018. Only five out of 15 strategists have a higher target than Friday’s close. And with Friday’s gains, this bull market is now the second-largest on record.
There are flaws to be found.
Breadth remains poor with fewer than 55% of the issues on the NYSE moving higher on Friday. SentimenTrader notes that on a day when the S&P 500 gained more than 1% to a new high, this has only happened four other times since 1965: March 1987, March 1999, November 1999 and December 1999. Both were dangerous years for market bulls.
The CBOE Volatility Index has also decoupled from its usual inverse correlation with stocks to march higher amid a foam-at-the-mouth stampede into call options as traders look for leveraged exposure to rising prices. Corporate cash flow growth is slowing, bringing to mind the old adage that revenue is vanity, profit is sanity, cash is reality. And inflation is set to rise as crude oil zooms back to 2014 levels, the potential GDP-to-GDP gap closes, and the labor market grows ever tighter.
Moreover, the specter of a more aggressive Fed hike path cannot be dismissed, with a new chairman on the way and a more hawkish makeup of Fed voters this year. The U.S. Treasury recently warned that given ultra-low bond yields and the lengthening of average maturities, merely a 1% rise in bond yields would result in a $1.2 trillion loss for the fixed-income markets.
But above all, cash levels are ultra-low (with Bank of America Merrill Lynch noting customer cash at 10% vs a low of 11% in April 2007) while retail traders are now fully engaged. SentimenTrader highlights that trading activity at E-Trade and TD Ameritrade accounted for 34% of NYSE transactions so far this month — more than triple the low of 2016. Free app-based brokerage Robinhood is getting into Bitcoin trading.
All indications suggest this is the terminal phase, where gains come rapidly as downside risks rise. The last 3% pullback was in November 2016, 448 days ago. That beats the previous record that ended in December 1995 of 370 days by a wide margin.
Check out Serge Berger’s Trade of the Day for Jan. 30.
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.
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Anthony Mirhaydari is the founder of the Edge (ETFs) and Edge Pro (Options) investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.
