Has The Market Met Its Match?

Fred Imbert of CNBC reports the Dow drops more than 200 points, stocks head for losing week as coronavirus fears resurface:
Stocks fell sharply on Friday after the number of new coronavirus cases escalated, fueling worries over a pronounced global economic slowdown.

The Dow Jones Industrial Average closed 226 points lower, or 0.8%. The S&P 500 slid 1.1% while the Nasdaq Composite declined by 1.8%. The Dow had its worst daily performance since Feb. 7 while the S&p 500 posted its biggest one-day loss since Jan. 31. The Nasdaq recorded its worst session since Jan. 27.

Friday’s losses put the major averages on pace for their first weekly losses in three weeks. The Nasdaq is down roughly 1.9% week to date. The Dow and S&P 500 are both down at least 1.5% for the week.

Microsoft and Nike fell more than 2% each to lead the Dow lower. The S&P 500 was pressured by a 2.6% drop in the tech sector. Facebook, Amazon, Netflix, Google-parent Alphabet and Apple all traded at least 1.7% lower to drag down the Nasdaq lower. In turn, money poured into U.S. bonds, pushing the 30-year rate to an all-time low.

China’s National Health Commission reported more than 75,000 confirmed cases and over 2,000 deaths on the mainland. More than 800 new cases were reported in China overnight. South Korea has also reported more than 200 cases.

“Even if the outbreak recedes, global growth is still set to fall to zero in the first quarter, before bouncing back over the remainder of the year,” Peter Berezin, chief global strategist at BCA Research, said in a note. “Thus, a near-term hit to corporate earnings now looks unavoidable.”

The spread of the virus is already taking its toll on the Chinese economy. Data from the China Passenger Car Association showed auto sales plummeted by 92% in the first two weeks of February. Some U.S. companies, including Apple, have also warned this week about possible revenue headwinds due to the virus.

IHS Markit also said activity in the U.S. services sector hit its lowest level in more than six years, noting confidence was “subdued” to the coronavirus.

Traders plowed money into safe havens such as Treasurys and gold on Friday. The 30-year Treasury bond yield hit a record low, breaking below 1.9%. Yields move inversely to prices. Gold hit a fresh seven-year high, gaining 1.6% to $1,645.90.

“This seems like a textbook defensive rotation,” said Frank Rybinski, chief macro strategist at Aegon Asset Management. “You’re starting to see hard-dollar impacts for companies because their supply chains are being disrupted.”

U.S. stocks are coming off a negative session driven by a sudden midday sell-off which confounded traders and brought markets back from previous record highs. The Dow also notched its fourth decline in five sessions.

“Markets had their first real ‘shot across the bow’ in a few weeks time, with a sudden swift pullback to multi-day lows, which was severe enough to cause some rapid buying of volatility,” said Mark Newton, managing member at Newton Advisors. “Yet breadth was never down that much even at the height of intraday losses, and ended up positive on the day.”

In corporate news, Deere shares popped more than 7% on quarterly earnings that beat analyst expectations. Dropbox soared more than 21% after it posted a profit that topped estimates.
It's Friday, time to kick back and analyze another wild and crazy week in markets.

First, let's begin with the latest on the novel coronavirus. Experts now predict that COVID-19 will spread more widely. According the World Health Organization, the coronavirus outbreak is reaching a global tipping point, and the window to contain it is 'narrowing,' which is why leading epidemiologists are trying to gather as much information as possible from quarantined passengers on the Diamond Princess to learn more about COVID-19:

Hardly shocking to me, I've been warning my readers for three weeks not to underestimate this novel coronavirus and its impact on the seemingly unstoppable US stock market.

In particular, I kept harping on the evidence that showed there are documented cases of asymptomatic transmission, but the US stock market didn't care, tech stocks kept melting up as traders shrugged off the bad news in China.

Here's the problem, as central banks keep pumping billions into the financial system to keep the bubble stock market going, even they realize that all the QE in the world is futile when faced with a global pandemic.

Importantly, even the mighty US stock market will crater under the immense pressure of a sharp slowdown in global economic activity. What happens in Asia will impact the rest of the world. Chinese not buying cars signals a recession will hit Japan and Germany, and that's just the tip of the iceberg. When you factor in the disruption in global supply chains, there's more bad news coming.

Amazingly, people are not listening to experts, or at least not listening very carefully, and here we are on the verge of another global pandemic.

As I keep telling my readers, pandemics aren't bullish for risk assets like stocks, corporate bonds and commodities, they're deflationary and bullish for bonds as everyone runs scared looking for safety.

Given this background, nobody should be surprised that the US long bond ETF (TLT) is breaking out here, making a new 5-year high as long bond yields plunge to record lows:

Two years ago, the Oracle of Omaha was "baffled" by 30-year bonds, and I felt like the only schmuck recommending bonds in a diversified portfolio because I considered (and still consider) them to be the ultimate diversifier.

When someone tells you "bonds are for losers", kindly refer them to this blog and respectfully suggest they don't have a clue of what they're talking about.

"But Leo, you can make a lot more money riding the wave in tech stocks, especially monsters like Tesla".

Absolutely, but you can also lose a whole pile of money too and unless you have lived through the tech meltdown, you have no clue of what's coming ahead.

I agree with Jim Bianco of Bianco Research, when you see this cover on The Economist, run for the hills:

Speaking of Jim Bianco, he recently appeared on a program stating while stocks expect a V-shaped recovery, the bond market is signalling a U or L-shaped recovery from the coronavirus:

We shall see, as I write this comment, stocks are getting slammed hard, led by Technology (XLK) which is this week's worst performing sector:

Real Estate (XLRE), Utilities (XLU) and Consumer Staples (XLP) are the best performers this week because they're the "safe sectors" that outperform when investors are nervous and bond yields keep plunging.

But I warn you, there's so much money plowing into tech and defensive sectors (barbell trade) that at one point, these sectors will decouple from lower bond yields and get hit too.

By definition, a real bear market means there's nowhere to hide. We're not there yet -- actually far from it -- but some are preparing for the coming crash while others are more interested in what top funds are buying.

When I look at the daily chart of the S&P 500 ETF (SPY), I see a pullback underway:

How bad will it get? Nobody knows, but when I look at the 5-year weekly chart, this is just a little blip thus far:

Importantly, the S&P 500 ETF (SPY) has not fallen below its 10-week moving average in a long time as CTAs and quants keep buying every major dip but I think this time the jig is up.

On Thursday, we saw an intraday crash in tech stocks reminiscent of Quant Quake 2.0 which we experienced last September.

The market came back but some are wondering whether this is the start of a major factor crash where growth stocks (SPYG) get hit and value stocks (SPYV) take off:

I'm not so sure but looking at that last chart, there could be a reversal going on right now away from growth into value stocks.

A lot of quants try to get cute on factor investing but most investors ignore all this and just buy the entire index (SPY) because when you try to time factors, most of the time, you'll get it wrong.

Still, make no mistake, there's a lot of concentration risk going on which is why Morgan Stanley's Mike Wilson is warning investors: "All Aboard the Crazy Train".

Other strategists are "irrationally bullish" but remain worried the end is near:
[Last] Friday, Michael Hartnett at Bank of America Global Research wrote, “We stay ‘irrationally bullish’ in [the first quarter].”

Hartnett notes that investors aren’t euphoric, he argues the Fed is caught in a liquidity trap, and he expects the “rising probability of a ‘Minsky moment’ to coincide with peak positioning & peak liquidity in Q2 triggering [a] ‘big top’ in risk assets.”
This week, Hartnett said he's so bearish, he's bullish but warned there are signs the top is near.

And then there is Marko Kolanovic, JPMorgan's global head of macro quantitative and derivatives who appeared on CNBC this week stating the bubble in defensive and tech stocks ‘will likely collapse’:
“Bonds, momentum stocks, and low volatility stocks rallied – pushing the valuation spread between defensive and cyclical stocks to a level 2x worse than during the peak of the late-’90s tech bubble,” Kolanovic said in a note to clients on Wednesday. “The bubble we are describing is expressed in equity factors ... We caution investors that this bubble will likely collapse, i.e. this time is not ‘different.’”

Kolanovic added some tech names are trading at “unsustainable valuations” supported by record level of speculative call option activity.

“Value stocks are typically on the other side of all of these trends that inflated this bubble,” Kolanovic said. The strategist had called the rotation into value stocks in September that rocked investors. He called it a “once in a decade” trade then.
Kolanovic makes a lot of sense but as I said, timing these markets based on factors is very difficult.

Below, Marko Kolanovic, JPMorgan global head of macro quantitative and derivatives strategy on whether the market is in a bubble. With CNBC's Brian Sullivan and the Fast Money traders, Tim Seymour, Chris Verrone, Karen Finerman and Guy Adami.

And CNBC's Brian Sullivan and the Fast Money traders, Tim Seymour, Chris Verrone, Karen Finerman and Guy Adami discuss what spooked the stock market on Thursday. 

Just a little taste of what lies ahead. Get ready for Quant Quake 3.0, the market has finally met its match.