Traders and investors returned from the last hurrah of summer and were greeted with a cold dose of reality Tuesday. Isis extremists are beheading journalists. Russia backed separatists are on a roll in Ukraine. Major central bank decisions loom. And corporate bonds are under pressure — especially junk bonds — in a way that has accompanied turbulence for stock prices.
While the S&P 500 did all it could to stay above the 2000 level on Tuesday, key areas of the market are already buckling under pressure. Energy stocks in particular are showing signs of weakness. And currencies were extremely lively, with the U.S. dollar surging against the yen.
The question now is: Where does the market go from here?
Market history suggests caution is warranted. September is one of the poorer-performing months of the year historically, with an average loss of 0.5% for the S&P 500 since 1950.
Moreover, September has been the stage for some large-scale pullbacks, including a 7.2% drop in 2011, a 9.1% drop in 2008, an 11% drop in 2002, and an 8.2% drop in 2001. ?In fact, September was a down month for four years in a row through 2002.
The geopolitical situation remains dicey not only in Ukraine but throughout the Middle East as well. Overnight, there were multiple concerning reports out of Saudi Arabia. There was a small attack on an oil pipeline in the east after officials detained 88 individuals that were said to be planning terrorist attacks.
Outweighing all this, for now, has been the steady march of solid economic data.
This morning, the ISM Manufacturing index climbed to its best level in three years in August with the new orders component rising to its best level since April 2004. This is lifting expectations heading into Friday’s all-important payroll report, with analysts looking for payrolls to expand by around 200,000.
Unless this economic enthusiasm translates into broader market participation to the upside, I think stocks will run into trouble in the days to come.
For one, the percentage of NYSE stocks above their 50-day moving average stands at just 65% — despite the S&P 500’s push to record highs — compared to nearly 85% when the market was making new highs back in June and July.
Also, the CBOE Volatility Index (VIX), Wall Street’s fear gauge, tested above its 50-day moving average again today — as it did last week — in a sign that options traders are paying real money for protection against a downside move in stock prices. The VIX is been rising over the last two weeks in defiance of the S&P 500’s push to new records.
Click to Enlarge But it’s the drop in junk bonds, as represented by the iShares High Yield Corporate Bond Fund (HYG) that has me most concerned.
Bonds are the backbone of the market, given the influence years of cheap money stimulus from the Federal Reserve has had on yields, spreads, and the usage of cheap credit by executives to bolster stock prices via share repurchases and higher dividends. Another bout of weakness in junk bonds will suck the wind out of stocks.
Given the poor seasonality, the technical issues, the bond market weakness, and other catalysts (geopolitics, looming central bank decision) I’ve recommended investors raise some cash and plan on thinking defensively at least through Election Day in November.
Click to EnlargeNew opportunities on the short side are popping up, such as General Electric (GE), which has lost its 200-day, 50-day, and 20-day moving averages.
I’ve added a put options position in GE to my Edge Sample Portfolio.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm.
