A Picture is Worth a Thousand Words

The old adage, “a picture is worth a thousand words” comes to mind when looking at the price action posted by US equity markets in the month of August thus far. The chart below of the Dow Industrials is a great case in point. As is evidenced by the chart, days where significant price erosion has been posted, volume has escalated – effectively informing investors that institutional interests have been reducing equity market exposure and risk. Equally important, attempts at a rebound have been anemic – both in terms of advance/decline metrics, but also in terms of volume. As a reader of this weekly note, you know that this month’s heightened volatility and sell-off was not at all unexpected.

What is more important, however, is how our month-to-date price action is likely to inform equity market performances in September and into the year-end.

Not unlike the Dow Industrials Index, the S&P 500 and Nasdaq Composite have also suffered under significant selling pressure. In the process, both indices have also exhibited similar trading patterns. The dominant themes that are driving this risk-off trade are familiar: the escalating US/China trade war and frustration with the Fed’s unwillingness to lower interest rates in a more deliberate fashion. Both themes took on an escalated posture last week – effectively driving equity prices lower and setting up equity markets for a potential follow-through trade lower.

The Dow Industrial average closed on its 200 DMA on Friday. That should speak to a degree of technical support for the market, but given the volume metrics on the day, advance/decline ratio, and the fact that it closed just off the lows of the week and session, it is safe to say that the momentum is lower for equity prices. I do not expect the 200 DMA to act as meaningful support this time around. In fact, I would not be at all surprised to see the Dow trade to 24,600 in coming weeks – potentially by the end of Q3. That level would effectively place the Dow 10% off its record closing high. I expect similar price action from the S&P 500 with 2724 being a 10% reset and the Nasdaq composite with 7506 being the target.

The S&P 500 and Nasdaq both closed sharply lower as well on Friday, but just fractionally above their respective 200 DMAs. In both cases, momentum to the downside is firmly established.

In the case of US/China trade, President Trump stated that he would raise tariffs again and requested that US-based companies begin the process of looking for alternatives to China for manufacturing. In the case of the Fed, President Trump has excoriated Fed Chair Powell for not moving to lower rates. Fed Chairman Powell’s attempts to mollify investors concerns over expectations for slower growth in Jackson Hole, Wyoming last week were overshadowed by US/China trade and President Trump.

The two themes are directly related, but of the two, US/China trade is the dominant one. That can best be seen by the trade that took shape on Friday after President Trump raised the stakes in the trade dispute that has increasingly taken on the profile of a full-blown war.

On Friday, all three major US equity indices were hit hard. The Dow Industrials lost 623.34 points, or 2.37%. The S&P 500 lost 75.85 points, or 2.59%. The Nasdaq Composite gave up 239.62 points, or 3.00%. More telling than simply the sell-off was the volume that accompanied it. Volume on the NYSE rose 42.45%, while volume on the Nasdaq rose 23.82%. The current market trend is “uptrend under pressure.” It feels more dire. In coming weeks, if not this week, we may well see that trend shift to “market in correction.”

As of Friday’s close, the Dow industrials and S&P 500 are 6% off their all-time highs, while the Nasdaq Composite is 7% lower. It would only take a repeat of Friday’s losses to get us fractionally close to correction, technically speaking. Given the backdrop that has fueled this risk-off trade, that isn’t much of a stretch. Even if all we do this week is lose 3%-4% for the week, we are there.

The interesting thing is that though we have seen significant losses for US equity markets in August, the backdrop of US economic data is not as bleak as you might expect – based on the most recent economic data releases. E-Commerce sales in Q2, released last Monday, were significantly stronger than expected, coming at 4.2%. Weekly jobless claims, released last Thursday, were also better than expected: 209k vs 216k. Leading Indicators for July were also stronger than Econoday consensus – coming in at 0.5% versus 0.2%. Existing home sales for July came in at 5,420 M – better than consensus of 5,385 M. New home sales for July were lighter than Econoday consensus: 635k versus 645k.

Net/net, it is difficult to make a compelling argument that the US economy is suffering from indications of cycle-end. There have been weak spots in our recent economic releases in manufacturing and housing. And yes, we have seen GDP begin to wain relative to what we saw as a result of the Trump tax act, but a slowdown does not a recession make. The economy is also not flashing signs of trade-induced stress.

What we have on our hands is a trade war-induced panic of sorts that happens to dovetail neatly with calls for lower interest rates by both the street at large and the President. Those themes are enough to drive equity prices lower – and probably lower than many are expecting in the near term. Is this the end of the bull run in equities? It is too early to tell – just don’t tell the US consumer the party is over, because by nearly every measure, they seem to be doing just fine.

Flickr photo: PMillera4
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