A subtle shift in mood took hold on trading desks and trading floors from one end of Wall Street to the other. It suddenly felt as though the rally that catapulted U.S. equities to their best weekly performance in years had evaporated just as quickly and unexpectedly as it had appeared nearly two weeks ago.
Yesterday’s price action on U.S. stock exchanges begs the question; was last week’s rally simply a short cover? Was there more to last week’s sharp rally than simply shorts covering and value investors adding to positions? In either case, one thing that is for absolutely certain, investors have been afforded the opportunity to take a deep cleansing breath and an opportunity to reassess their risk tolerance.
Two things stood out in yesterday’s trading; volume surged and prices moved lower. Make no mistake about it, it was not a mixed session. It was decidedly negative and there was a return to an undercurrent of “Risk Off” in the trading narrative as well. All three major U.S. equity indices lost ground as did the Russell 2000. In order of performance, the indices that are least associated with inflated valuations did best while that with more elevated valuations did worse. The Russell 2000 for example lost 1.47% on the day while the NASDAQ lost 0.87%. On the other hand the Dow Industrials slipped a slight 0.29% while the &P 500 ticked 0.68% lower. In short the Industrials and S&P outperformed the NASDAQ and the Russell 2000 by a meaningful margin. Volume on the NYSE rose by 15.75% and also rose on the NASDAQ by 14.22%. The rise in volume can fairly be tied to the bank holiday on Monday. As a result of the negative price action on expanding volume, yesterday marked a distribution day. The current outlook remains unchanged: confirmed uptrend.
As I have suggested in recent notes, the test of any move higher will be how the major indices react when they run up against recent resistance. As a result of the sharp selloff that defined our August and September trade, the 50 DMA is BELOW the 200 DMA on all three US equity indices. As a result, the first test comes at the 50 DMA. In that case, the NASDAQ (YTD +2.28%) did trade above and close above its 50 DMA on Monday but rather unceremoniously closed below that level yesterday. The S&P 500 (YTD 1.09%)has performed slightly better. Last Thursday it traded above its 50 DMA and has managed to close above it everyday since – including yesterday. The Dow Industrials (YTD – 2.34%), the most relatively conservatively valued of the three, closed above its 50 DMA a week ago and has also managed to stay elevated above that key technical level.
Now that the seemingly effortless rebound that took shape last week has run its course, the market’s mettle will be tested against the backdrop of Q3 earnings and forward looking guidance. As I have touched upon in recent notes, S&P Capital IQ is calling for significant revenue compression for its constituent components, but given our recent move lower, that headwind is likely largely baked into prices. That said, Intel and J.P. Morgan released its quarterly earnings report yesterday. J.P. Morgan missed estimates for the quarter, reported a decline in revenue and a decline in the profitability of three core businesses. Being the nations largest bank, J.P. Morgan is closely watched as a bell-weather for the financial sector. As a result, the tone has been set for the space and it will not trigger a great deal of enthusiasm. Intel beat lowered expectations, posted flat revenue, lower profit and cut revenue growth targets to due weak macro-growth demand. Again, a bell-weather company that delivered mixed results – more tone confirmation only this time in the large cap tech silo.
The reference in Intel’s report to weak macro-growth was underscored by import figures for China that reflected an 11th consecutive month of decline.
Though it is early in the quarter, results seem to match much of the apprehension that set into markets yesterday. The sledding gets tougher. Interestingly, the volatility index rose 9.28% yesterday to close at 17.67. The US 10-year yield slipped 1.67% to close at 2.0550%.