The Bad Santa Selloff of 2018?

Thomas Franck of CNBC reports, Dow dives 400 points, heads for worst week in 10 years:
Stocks plunged again on Friday, sending the Dow Jones Industrial Average to its worst week since the financial crisis in 2008, down nearly 7 percent. The Nasdaq Composite Index closed in a bear market and the S&P 500 was on the brink of one itself, down nearly 18 percent from its record earlier this year.

The Federal Reserve’s rate hike on Wednesday drove the losses this week and fears of an extended government shutdown only added to the pain on Friday.

The Dow Jones Industrial Average fell 414.23 points to finish at 22,445.37 in turbulent trading that sent the blue-chip index up as much as 300 points earlier in the day, only to trade back in negative territory less than one hour later. The initial rally upward on Friday came as Federal Reserve Bank of New York President John Williams told CNBC that the central bank could reassess its interest rate policy and balance sheet reduction in the new year if the economy slows.

But those gains slowly disappeared as investors used that short-term pop as a chance to sell more. The broader S&P 500 fell 2.1 percent on Friday to close at 2,416.58, while the tech-heavy Nasdaq Composite shed 2.99 percent to 6,332.99 with big losses in technology stocks including Facebook, Amazon and Apple.

Stocks accelerated to their lows after President Donald Trump’s trade adviser, Peter Navarro, told Nikkei that it would be “difficult” for the U.S. and China to arrive at a permanent economic agreement after a 90-day ceasefire in the trade tensions.

Here’s a tally of the carnage:
  • The Dow lost 6.8 percent and 1,655 points on the week. It was its worst percentage drop since October 2008.
  • The Nasdaq lost 8.3 percent on the week and is now 22 percent below its record reached in August, a bear market.
  • The S&P 500 lost 7 percent for the week and is now down 17.8 percent from its record.
  • The Dow and S&P 500, which are both in corrections, are on track for their worst December performance since the Great Depression in 1931, down more than 12 percent each this month.
  • Both the Dow and the S&P 500 are now in the red for 2018 by at least 9 percent.

The selling had conviction. More than 12 billion shares changed hands on U.S. exchanges on Friday, the heaviest volume in at least two years. The expiration of options also added to the volume.

“The message people should take home, especially if there’s a government shutdown, is that longer term, the prospects for equities are not good,” said Komal Sri-Kumar, president of Sri-Kumar Global Strategies. “There are lots of signs now suggesting that we may be looking at a recession. I would say that the risk here is that a whole lot of confluence is taking place: The trade war is not going to end soon, and the Fed totally misjudged the market in suggesting two more rate hikes next year.”

On Thursday, the Dow Jones Industrial Average dropped 464.06 points to close at 22,859.6, bringing its two-day declines — which encompassed the market’s reaction to the Fed’s rate hike — to more than 800 points. The S&P 500 shed 1.58 percent to end Thursday at 2,467.41 while the Nasdaq Composite fell 1.6 percent and closed at 6,528.41. The Cboe Volatility Index — one of Wall Street’s best gauges of marketplace fear — rose above 30 on Thursday, its highest level since February.

Friday rollover

Stocks initially caught an early bid Friday morning after New York Fed President Williams said the central bank was listening to the market, and could re-evaluate its outlook for two rate hikes next year.

“We are listening, there are risks to that outlook that maybe the economy will slow further,” Williams told Steve Liesman on CNBC’s “Squawk on the Street” Friday.

“What we’re going to be doing going into next year is re-assessing our views on the economy, listening to not only markets but everybody that we talk to, looking at all the data and being ready to reassess and re-evaluate our views, ” he said.

U.S. equities quickly staged an about-face thereafter.

The Fed’s decision to raise the benchmark overnight lending rate by one quarter point on Wednesday triggered a new wave of selling across Wall Street earlier in the week. That move was widely expected by markets but investors appeared to be taken off guard by Fed Chairman Jerome Powell’s comments that the central bank was satisfied with its current path to reduce the balance sheet with no plans to change it.

“This is a real magnificent speech and much different from what most of us are accustomed to,” said Anthony Chan, Chief Economist at J.P. Morgan Chase. “The concern of the market was: what is the Federal Reserve going to do with the fed funds rate in 2019? John Williams told us everything’s on the table, they can adjust that path.”

“Then of course the markets are really worried about that autopilot situation on the balance sheet,” Chan added. “Once again, John Williams said even that is on the table, that if things were to shift, that the Federal Reserve would be flexible on that.”

The Fed currently is allowing $50 billion a month to run off its massive debt balance sheet as its securities mature, tightening financial conditions. The balance sheet is mostly a collection of bonds the central bank purchased to vitalize the economy during and after the financial crisis.

Government shutdown concerns

Sentiment was dampened Friday after President Donald Trump aggravated fears of a government shutdown after tweeting:

“The Democrats, whose votes we need in the Senate, will probably vote against Border Security and the Wall even though they know it is DESPERATELY NEEDED. If the Dems vote no, there will be a shutdown that will last for a very long time. People don’t want Open Borders and Crime!”

Equities fell to their lows of the day in the previous session after U.S. House of Representatives Speaker Paul Ryan announced that President Trump would not sign a temporary government funding resolution without funding for a U.S.-Mexico border wall.

Later on Thursday, the House passed a temporary spending bill with more than $5 billion for Trump’s border wall — an inclusion which will likely impede its ability to clear the Senate. The Senate had unanimously approved a bill Wednesday night to keep the government running through Feb. 8 — without border wall money.

However, Trump later told reporters on Friday that there is a very good chance the House funding bill will not pass in the Senate and that the administration is prepared for a long shutdown.

“Although shutdowns get a lot of media hype, the reality is that stocks tend to take them in stride. In fact, the S&P 500 has gained during each of the five previous shutdowns,” explained LPL Senior Market Strategist Ryan Detrick.

Both House Minority Leader Nancy Pelosi and Senate Minority Leader Chuck Schumer have flatly said congressional Democrats will not approve wall money. As Republicans need Democratic votes to pass spending legislation in the Senate, a partial shutdown is all but assured if the GOP insists on funding for the barrier.
What's that old expression, when it rains, it pours?

It's been a disastrous week in markets, I wasn't going to post anything today but given the fear out there, I feel it's only appropriate to go over a few market developments.

First, have a look at how markets fared on Friday (click on image to enlarge):

As you can see, the Nasdaq led the downturn, down 3% in one day and down 8.3% just this week.

I want to show you a chart of the S&P Technology ETF (XLK) which you absolutely need to keep in mind as this selling unfolds (click on image):

The bad news is short sellers are gunning to bring this below its 200-week moving average, which is another 10% drop. Bulls are going to try to defend the 150-week moving average but FAANG stocks have a bullseye on them (click on image):

And it's not just FAANG stocks. Have a look at the S&P Biotech ETF (XBI) which got decimated again this week and is now firmly in bear market territory (click on image):

Not surprisingly, since biotechs are the riskiest stocks, they got clobbered the most after the Fed raised rates a cumulative nine times. Add to this redemptions hitting biotech funds at year-end and you have a wave of selling that makes for a capitulation in this sector (but don't try catching this falling biotech knife!).

The rout in biotechs and fear in markets placing a premium for liquidity are some of the reasons why US small caps (IWM) are suffering one of their worst quarters in history:

Interestingly, while biotechs are getting destroyed, investors are finding refuge in big pharmaceuticals stocks like Merk (MRK), Pfizer (PFE) and Eli Lilly (LLY), all of which have done very well this year.

Other leading sectors of technology are also weakening fast. Semiconductor shares (SMH) sliced below their 100-week moving average and are at risk of going a lot lower here (click on image):

It's hard to see a rally in technology without FAANGs, biotech and semis, this is why it's critical to look at all components when trying to assess price movement in the Nasdaq.

What else? Despite the rate hike this week which normally bolsters big banks, the S&P Financials ETF (XLF) has been falling like a stone and is very close to declining below its 200-week moving average (click on image):

Adding to worries, US banks are stuck with $1.6 billion in buyout loans they cannot sell, heightening fears that the loan market is freezing:

Any normal Fed attuned to markets would be looking at financials tumbling like this and cutting rates and increasing its balance sheet operations.

But not the Fed Grinch who stole Christmas, Mr. Powell is a private equity guy, probably never traded in his life as he made multi-millions in private markets, and doesn't seem concerned about the stock market.

No wonder President Trump is considering firing him, something I discussed in my last comment and made my own personal views public on Twitter:

This won't save the markets from Powell's big blunder but it will reassure many market participants who are concerned that the Fed is out of touch with what's going on in markets.

Interestingly, it didn't take long for New York Fed President John Williams to come out to attempt to do some damage control but it's too little, too late, the damage is already done:

President Trump's obsession with building that bloody wall and threatening another government shutdown only added gas on the fire which makes you wonder if he's in cahoots with hedge funds shorting this market.

All these factors turned this year's much anticipated Santa rally into a disaster:

And that's no laughing matter. The amount of wealth destruction going on in a few short weeks is obscene and many people are rightly concerned, especially those who are looking to retire next year.

So what now? The only thing I can tell you is to keep in mind certain things before reacting irrationally:
  1. Pension funds and sovereign wealth funds rebalancing: Large institutional investors need to rebalance at the end of the month, quarter, year, especially after such a violent move. I'm talking about large multi-billion dollar funds who need to maintain their equity allocation at a certain weight and will likely sell some bonds which fared well this quarter to buy more stocks which got clobbered. Zero Hedge today warned to brace for "seismic" volatility as pension funds are set to buy a record $60 billion in stocks in coming days but I think that figure is on the low side when you include international pension behemoths like Norway's pension and Japan's GPIF.
  2. Large leveraged players are now net long equities: A friend called me earlier to tell me the latest CFTC commitment of traders report which came out Friday afternoon, shows speculators are more net long equities than in the previous week. Just two weeks ago, they were net short.
Still, there are things that concern me. First, the high yield bond ETF (HYG) had a terrible week and fears of a credit crisis don't portend well for stocks (click on image):

What else? I'm keeping my eye on interest rate sensitive sectors like the S&P Homebuilders (XHB) which tend to lead the overall market lower or higher and they rolled over this week and remain firmly in bear market territory (click on image):

But Fed Chair Powell thinks the US economy is fine, firing on all cylinders. Yeah, right!

I will end by showing some fear gauges I track. First, the VIX was up 6% today and settled at just above 30 (click on image):

A lot of commentators like Gundlach stated the VIX needs to spike above 40 for there to be an interim bottom to the selloff.

Maybe but when I look at the weekly chart of the iPath S&P 500 VIX ST Futures ETN (VXX), I'd say we reached an important fear inflection point this week (click on image):

Also, Zero Hedge posted a comment on panic in the air which showed more gauges of fear reaching extreme levels which typically suggests the selling is way overdone. You can read it here.

So, to all my readers, try not to let this bad Santa selloff rattle you, markets are there to inflict maximum frustration and angst among all participants.

I'm not saying there won't be a bear market or things can't get worse, but the ferocity of this downtrend leads me to believe that cooler heads will prevail and smart short sellers will cover and wait for a better opportunity to short stocks again.

Alright, that's enough market talk, wasn't supposed to blog today but I felt compelled to discuss this week's nasty selloff because many people are rightfully scared, confused and worried.

Below, New York Fed President John Williams says the Fed could re-evaluate view in 2019. Again, too little, too late, the Fed blew it this week, making a monumental mistake of epic proportions.

With stocks on a brink of a bear market, and many leading sectors already in a bear market, I expect NO rate hikes next year, and possibly a few rate cuts and more QE if we get a crash (always hedge your equity exposure with US long bonds!).

Second, CNBC Markets Now provides a look at the day's market moves with commentary and analysis from Michael Santoli, CNBC Senior Markets Commentator.

Third, Mark Yusko, Morgan Creek Capital, discusses his take on markets and the volatility hitting stocks and why he thinks there's a lot more pain ahead. He tells you to hide out in the same defensive stocks I told you about in July, namely, healthcare (XLV), utilities (XLU), consumer staples (XLP), REITs (IYR) and telecoms (IYZ). He also rightly notes that US long bonds (TLT) might outperform the S&P again next year, especially if a nasty bear market ensues.

Lastly, the trailer of Bad Santa. If you want to forget these dreaded markets, my advice is to watch something funny and relax this holiday season.

That's it from me, I'll be back next week to discuss pensions, markets and do a quick recap of the year.

I remind all of you reading this blog to please contribute to it on the right-hand side, under my picture, using PayPal options. I thank all of my supporters and wish you a Merry Christmas, Happy Holidays and a Happy & Healthy New Year!