Crossing Wall Street Review – August 18, 2017
By Eddy Elfenbein, editor of Crossing Wall Street and portfolio manager of the AdvisorShares Focused Equity ETF (NYSE Arca: CWS)
Three times in the last six trading sessions, the S&P 500 had a daily move of more than 1%. Normally, that’s no big deal, but in 2017, it’s enough to get your attention. Last year, the S&P 500 had 48 days in which it closed up or down by more than 1%. In 2015, there were 72. So far this year, there have been seven.
Here a remarkable stat: Not once since election day has there been a 3% drawdown for the market. In other words, from top to bottom, the S&P 500 has never been down by more than 3%. That’s the longest such streak on record. For more than nine months, it’s been a baby-step rally the whole way. However, there are a few disparate events that seem to be coming together all at once that could shake things up. Let me take them one at a time.
I was critical of the last Fed rate increase. Now it appears the market is starting to doubt the Fed’s commitment to more rate increases. The futures market had been expecting a third rate increase this year in December. Now the odds are slightly against it. Traders don’t give a 50% chance for another rate increase until March 2018. That’s actually more hawkish than a few days ago, when the next hike was pegged for June 2018. Whatever the case, traders think the Fed will be on hold for several more months. By the way, I should add that Janet Yellen’s term ends in February. President Trump may reappoint her.
Speaking of the president, many of the investing themes that took hold of the market after the election have quietly melted away. A good example is small-cap stocks. Last November, the Russell 2000 soared. There was a great deal of optimism that the new administration would be a boon for smaller companies. (Please note: I’m not making a political statement. I’m merely reflecting what traders believed at the time.)
But the sector soon started to lag the baby-step rally. In the last month, the Russell 2000 has been drifting lower in absolute terms. On Thursday, the index dropped below its 200-day moving average, which is often a bad omen. The Russell hasn’t traded below its 200-DMA in more than a year.
Watching the small-cap sector is important because it could be an early warning sign that investors are pulling back on riskier names. In a bull market, you want to see stable blue chips rally along side the up-and-comers. Whenever the score tilts heavily to one side, you know something’s up.
Here’s what happening: On the surface, we’ve seen a baby-step rally. The S&P 500 is moving mostly upward, with very low volatility. But below the surface, investors have been quietly shunning riskier areas and fleeing to safety. Or rather, perceived safety. But this is unusual, because it’s the opposite of what we normally see in the late stages of a bull run. Typically, when investors exit safety and chase madly after risk, that’s a sign of a frothy market.
On top of that, we’ve seen pronounced weakness in the U.S. dollar all year. Mind you, that’s not all bad. In fact, the weak dollar probably bailed out the market this earnings season. But are all these trends separate or are they different expressions of the same event?
One possible explanation is that the economy simply isn’t as strong as people thought. That’s why investors are shifting toward safety. Despite a low unemployment rate, GDP isn’t moving so fast, and that could require more assistance from the Fed. Lower rates, or a slower increase in rates, would also make the U.S. dollar less attractive.
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