Stocks zinged higher this week despite a -5% start after China’s central bank set the yuan at a firmer rate against the dollar. This eased concerns that a brewing trade spat between the two countries was about to move into an all-out currency war.
But the calm didn’t last long. Today President Trump said he’s not ready to make a trade deal with China, and said the U.S. will no longer do business with telecom giant Huawei.
We’re all relieved to see such a strong reversal at this point. But it is the strength that makes it noteworthy. Quantitative sentiment expert for Jason Goepfert notes:
Traders were staring at large losses and potential new lows early in the session on Wednesday, but steady buying pressure pushed the major indexes up all day, carving out one of the most impressive reversals in recent memory.
For the S&P 500, this was the first time since April 2018 that it fell more than 1% intraday, eclipsing its lowest close of the past 30 days, then reversing enough to close up for the day. This kind of action has always led to follow-on buying in the past, almost without fail.
Since 1995, there have been 13 instances when the S&P 500 reversed a 1% intraday decline to a 30-day low while above its 200-day average. Average next-week return is 1.4%, +2.8% over two months, 6.1% in six months, with 87% of the instances positive. The most recent was April 4, 2018. The S&P 500 was down 0.2% in the next week but gained 3.7% in two months and 10.2% in six months.
Goepfert also looked at every time the S&P 500 hit a multi-year high, then fell more than 5% within two weeks. Out of the 16 instances, the S&P 500 rebounded to a new high 10 times. It went the opposite direction and fell into a correction (i.e. -10%) six times and fell another 5% beyond that only once. It never dropped into a bear market, at least within the next six months.
On average, it took a little over a month before the S&P 500 recovered to a new high, and never longer than 35 days.
When it fell, though, it tended to do so quickly, taking an average of 12 sessions to fall another 5% (a 10% total decline from the peak).
Actual returns were pretty good, especially over the next two to three months. Three months later, only one showed a meaningful decline. The last occurrence was Feb. 5, 2018. The benchmark index was up 2.5% two weeks later and +7.6% after six months.
Essentially, it’s highly unusual to see a severe, sustained decline after these quick pullbacks from a high. Only one of them lost more than an additional 10% at any point over the next few months, while seven of them gained more than 10% at some point over the next three months.
Sectors that tended to rebound the most consistently were utilities, energy, telecom, and health care.
Fast and Furious
So, the decline, while it came on hard and fast, wasn’t anything the market couldn’t handle. In fact, it’s handled such fast and furious declines before, bouncing back relatively quickly.
As previously stated, one of the contributing factors, the U.S.-China trade war, was eased by China’s central bank. But what about the other cause? Reaction to the Fed’s rate cut caused substantial backlash.
Out of the 120 times the Fed has cut interest rates since 1970, the only times the S&P 500 has suffered a worse loss in the next three sessions were in 1987 following the Black Monday panic, and September 2001 following the 9/11 tragedy. Not great company. Goepfert looked at the all-time worst reactions to rate cuts, with the largest losses in the S&P 500 over the next few sessions, and largest drops in 10-year yield (when investors rushed into the safe haven of notes and bonds). These poor knee-jerk reactions mostly weren’t indicative of longer-term trouble. Only one time, 2007, resulted in a long-term setback.
Bottom line: A bad few days, for sure. But probably not the beginning of the apocalypse
The end of the world as we know it?
But didn’t I just say the reversal shows this isn’t an apocalyptic event? Well, yes … But, of course, it’s more complicated than that.
Neil Shearing, chief economist at Capital Economics, published a provocative and timely note to customers this week. It provides a historical perspective on the deterioration of U.S.-China relations, and what could come next.
He touches on an unbelievable possibility:
Could this trade war signify the end of globalism as we know it?
According to Shearing, this really should come as no surprise. After all, we’ve seen waves of globalization in the past — think about the turn of the last century — and they’ve ended as well. But it’s the why that should be concerning.
Shearing gives two potential reasons for the end of our globalized era:
1) Technological change. This would be the “benign” cause, as natural progress and new tech make it easier and cheaper to produce material in one (i.e., domestic) place and manage otherwise expensive supply chains.
2) Protectionist policy. This would be the “malignant” cause. Currently, tensions are limited to only the U.S. and China. But the trade war is currently impacting other countries — for better and for worse. If repercussions continue to reach other borders, history shows we could see those countries implement policy that would protect them … at the cost of the global market.
While we can all hope for the former, benign cause, it’s worth noting that history shows us otherwise. Every wave of globalization has been ended by a deliberate effort by policymakers to push back against integration.
It’s too soon to say exactly how current events will pan out, but this casts the trade war escalation in a more ominous light. Shearing believes we may be witnessing the end of the world — and the global economy — as we know it.
But let’s check in back home for a few more reasons to stay positive.
The AAII survey from this Thursday found that the bull/bear ratio dropped below 32% this week … a super-low reading. This suggests private investors are really scared of stocks to a stunning extent, considering the benchmark indexes are so close to their all-time highs and the economy, while slowing, is still in decent shape.
Analyst Jason Goepfert found 18 previous instances of when the S&P 500 was over its 52-week average and the AAII Bull Ratio was 32% or worse since 1987. In all of them, stocks showed a perfect record of gains from two months later and beyond. Risk was tiny relative to potential reward.
He also notes that not only is the current Bull Ratio very low, it showed a dramatic drop this week, down more than 30% from last week. During any kind of market environment, this is extreme. Forward returns are exceptional in the two-month (+5.4%), six-month (+13.5%) and one-year (+20.6%) time frames, with the latter two showing gains 100% of the time.
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Jon D. Markman