There has been a significant change in the psyche of the stock market, and markets across all asset classes since early October 2018.
At the very end of the third quarter of last year, markets were humming along with stocks continuing to make new highs and the price of crude oil trading to its highest price since 2014. Economic data in the United States was the best in years with GDP growth booming as a result of tax and regulatory reforms and the lowest rate of unemployment since 1969. Buyers in stocks ignored some nagging warning flags in the background. A stronger dollar, higher interest rates from a more hawkish Federal Reserve, and the trade dispute between the U.S. and China did not stop the market from rallying from February through late September.
Markets got a little taste of what bear market conditions might feel like in late January, and early February 2018 as the new complexion of the Federal Reserve caused stocks to drop sharply over two weeks. However, the equities market came roaring back, and by late September it was back at record highs.
As stocks rallied from April through September, the leading indices seemed almost immune to any bearish news as sentiment took the market on a one-way path to the upside.
As the weekly chart of the E-Mini S&P 500 futures contract highlights, the selling at the end of January and beginning of February turned out to be just another short-term corrective blip on the radar that cemented the market’s sentiment that every dip is a buying opportunity. Markets always look the worst on the bottom and the best on the top. For the majority of 2018, the bull market in stocks continued to charge higher.
Investment advisors have trained their clients to buy any correction in stocks. The market’s price action and higher highs have supported an almost religious fever for the investment public when it comes to the stock market. Massive amounts of capital tied up in passive investment vehicles from 401K, IRA, SEP, and other types of accounts have flowed into the stocks market on a daily basis creating natural buying. At the same time, tax reform created an unprecedented amount of share buybacks from corporations adding a significant level of support for the equities markets. With all of that buying, on typical days, the path of least resistance in the stock market remained higher.
However, in early October cracks began to emerge and by the end of the year, all of the leading equity indices had fallen to lows for the year. Over the coming weeks, investors will receive statements with the unpleasant news that their accounts lost money in 2018. Sentiment in the stock market shifted from positive to negative during Q4. The U.S. central bank had been hiking rates since December 2015, but another increase in the Fed Funds rate at their final meeting of 2018 caused accelerated selling in stocks. Equities ignored quantitative tightening that commenced in October 2017, until recently. The trade issues with China has been lurking in the background as a bearish factor for the global economy.
On the first trading day of 2019, the CEO of Apple, Tim Cook, warned that profits for his company would suffer as their business in China has been challenging. When China catches an economic cold, the rest of the world comes down with the flu. Stocks fell in the wake of the profit warning by Apple. It is likely that Apple’s travails over the economic environment in China is only the first shoe to drop in a much broader landscape of contagion which continues to contribute to the shift in sentiment.
Before Q4, the stock market ignored negative and embraced and reacted to the positive inputs. Since October, when it comes to negative news, a little drizzle seems to be turning into a downpour of selling.
Sentiment is a powerful force, and these days, it is looking at markets from a glass half empty perspective.
Markets tend to be more volatile during bearish periods as they take the stairs higher and the elevator down. Therefore, trading with a disciplined approach could yield optimal results in the current environment.