GOVERNMENT STIMULUS PACKAGES COULD SPARK RALLY
We have a wildly oversold market that is, by historical standards, overdue for a 10-20% rally. It is possible the third bill making its way through Congress could bring back some buying conviction. From CNN:
Senate Republicans are racing to reach a GOP deal on a massive $1 trillion economic stimulus as the coronavirus crisis intensifies, despite facing criticism from Democrats who warn that efforts to swiftly pass a stimulus could be derailed if they are not included in negotiations now.
Senate Majority Leader Mitch McConnell on Wednesday said Republicans are "getting close" to a deal and has outlined a plan that would involve Republicans coming to an agreement before going to Democrats in an attempt to forge a bipartisan consensus.
In a sign of tension between Republicans and Democrats, however, Senate Minority Leader Chuck Schumer criticized the way that Senate Republicans are negotiating on the economic package on Wednesday, calling for them to do more to include Democrats.
After the market closed Wednesday, the ECB announced another in a long series of stimulus measures from policy makers around the globe. From FX Street:
ECB says to launch a new temporary asset purchase program of private and public sector securities to counter the serious risks to the monetary policy transmission mechanism. Says purchases will be conducted until the end of 2020 and will include all the asset categories eligible under the existing asset purchase program.
SHORT-TERM DEVELOPMENTS WORTH NOTING
During Wednesday’s session, the S&P 500 dropped below two levels noted on Twitter and then rallied intraday to close back above them. The 38.2% retracement for the 2009-2020 bull market sits at 2351, which is also the S&P 500 closing low on December 24, 2018. The market closed above 2351 at 2398.
There was also some “be open to a rally” evidence from some expected volatility readings. The standard VIX is still sitting at concerning levels, was green Wednesday, but was relatively tame given the broad range and significant drop in the stock market. It was the drop in one-month volatility expectations relative to three-month volatility expectations on Wednesday that says “stocks may try to get off the mat Thursday” (see graph below).
Many bullish setups have seen no follow through in recent weeks and those that have been followed by a green session have all turned out to be single session events. As of Wednesday’s close, the 2020 market has shown next to nothing.
TRADITIONAL SAFE HAVENS HIT AGAIN AS STOCKS DROPPED
As a money manager, when you wake up and see futures that point to a big drop in stocks and you have a big allocation to cash, bonds, and gold, you expect those portions of the portfolio to be green while the stock side is red. That was not the case for bonds and gold again Wednesday. From Bloomberg:
Some of the winners being dumped may include super-safe Treasury bonds, which might help explain why their rates are jumping (bond yields and prices move in opposite directions), which isn’t what you’d expect in a doomsday-prepping scenario.
The pain in traditional safe haven bonds is not limited to the United States. The Bloomberg text below relates to the experience in Europe:
“This is hard to rationalize given one would tend to think that risk aversion should operate as a zero-sum game wherein safe havens such as German bonds are the beneficiaries,” Rabobank strategists including Richard McGuire wrote in a note. “Investors appear to be pricing in a sizable budgetary deterioration throughout the euro area.”
Rabobank noted that even in previous times of trouble, such as the dot-com bubble and the euro-zone crisis, German bonds rallied due to the consequential haven demand -- unlike now.
“It potentially speaks to the gravity of the situation prompting investors to take a much more narrow definition of what is safe,” the strategists said, adding poor liquidity could also be interfering with the market’s signals.
THIS PLUNGE SIMILAR TO…
The S&P 500’s 28-day ROC closed at 28.32 today. The only other periods in the S&P 500’s history that featured a ROC that hit that level were 1987 and 2008. In both cases, a sharp countertrend move occurred. In both cases, the pop was retested in some manner. The 1987 case helps with the “a bottom could be starting to form now” end of the spectrum and the 2008 case helps us with the “we could still drop over 25%” end of the spectrum. In both cases, really good things eventually happened on the other side of the fundamental and volatility event.
MORE VOLATILITY EXPECTED
The standard VIX closed at 76.45 today. That represents an extremely elevated and extremely rare reading for volatility expectations looking out 30 days. We will enter Thursday’s session with an open mind and see how it unfolds. The term “unprecedented” can be used to describe numerous bearish events in recent weeks. We could view unprecedented events with a negative mindset or we can respect unprecedented events in the financial markets require unprecedented focus and determination if we wish to navigate to the opportunities on the other side.
This post is written for clients of Ciovacco Capital Management and describes our approach in generic terms. It is provided to assist clients with basic concepts, rather than specific strategies or levels. The same terms of use disclaimers used in our weekly videos apply to all Short Takes posts and tweets on the CCM Twitter Feed, including the text and images above.