You could argue that the market spooked itself this week.
Now it wasnâ€™t as if there werenâ€™t external reasons for the downturn. Between worries about slow vaccine rollout, weak European economic data, the appearance of the South African variant of the virus here, and a few disappointing earnings reports, itâ€™s easy to find a fundamental story to blame.
Still, it feels like the selloff, which accelerated Friday as theÂ S&P 500 IndexÂ (SPX) fell nearly 2%, was more of a reaction to internal market developments. Anyone whoâ€™s paid attention knows about allÂ the focus on short squeezesÂ that brought fame (and some fortune) to stocks likeÂ GameStop Corp.Â (NYSE: GME) andÂ AMC Entertainment Holdings IncÂ (NYSE: AMC). Thereâ€™ve been disruptions all over the world, and now the stock market is feeling some disruption and a change of tone. The short squeezes certainly had a lot to do with it. The way people interact with the market is a little different than in the past.
Thereâ€™s also a sense that things in general had come too far, too fast, sending values too high and leading to calls for a little consolidation. Basically, the four main stock indices had rolled along full steam ahead with hardly a break since early November, and that made some people nervous, especially about valuations. The short squeezes seemed to reinforce some investorsâ€™ beliefs that it was time for a little profit-taking.Â
Itâ€™s a storm of a lot of things coming together thatâ€™s leading to a disruption in the market overall. These kinds of disruptions occur every 10 or 12 years and the market has always survived them. People are reassessing their portfolios. Not just individuals, but funds, too. Thereâ€™s a reassessment of value everywhere.
Some of the major stocks leading the downward charge Friday included all the â€œFAANGsâ€� along withÂ Microsoft CorporationÂ (NASDAQ: MSFT).Â Apple IncÂ (NASDAQ: AAPL)â€”which often has an outsized impact on the overall market due to its huge valuationâ€”is down 8.5% since reaching an all-time high early this week. Thatâ€™s despite a stellar earnings report. Thatâ€™s the kind of thing that makes you wonder if weâ€™re seeing some good old-fashioned profit-taking.Â
From a sector standpoint, it looks like a few of the ones that had been doing best on the recent rally have fallen the hardest, including Energy, Info Tech, and Financials. The so-called â€œdefensiveâ€� sectors, including Utilities and Health Care, did best on Friday.Â
Bumpy Ride Not Out Of The Ordinary
It never feels good to lose money in the market, but it should feel familiar. Major indices generally experience several 5% drops each year and usually at least one 10% decline. The SPX hadnâ€™t had any sort of serious backtracking since September when it fell around 9.6% from its highs. Then it went on a tear, chalking up gains of nearly 18% from the end of October up to its all-time highs earlier this month.Â
Gains were even heavier for the small-capÂ Russell 2000 IndexÂ (RUT), which entered this week trading at about 1.37 times its 200-day moving average, the highest itâ€™s been relative to the 200-day since at least 2000. Hopes for further fiscal stimulus, the Fedâ€™s dovish monetary policy (which it againÂ promised this week to keep that way for the long term), and vaccine progress all helped electrify Wall Street between November and January.Â
Now it feels like maybe things got a little ahead of themselves, considering all the challenges we still face. Europe is running low on vaccines. The U.S. rollout has been slower than expected. TheÂ Johnson & JohnsonÂ (NYSE: JNJ) vaccine data today looked OK, but not amazing, and none of the vaccines seem to be as effective against this South African variant that has medical experts sounding nervous. Gross domestic product (GDP) growth in Q4 wasnâ€™t quite as good as some people had hoped and moderated from the breakneck pace of Q3.Â
Combine all that with earnings fromÂ Facebook, Inc.Â (NASDAQ: FB) andÂ Tesla IncÂ (NASDAQ: TSLA) that didnâ€™t blow anyone out of the water, cruise lines once again pushing back their schedules, a bond market that showed new life, risingÂ volatility, and an SPX valuation at historic highs, and it would have been kind of weird not to have some weakness in stocks.Â
Key Levels To Watch Include 30,000 In $DJI And 3700 In SPX
Despite this disappointing end to the week, try to keep things in perspective. The SPX is still up 13.5% in the last three months, and remains around 3.5% below this monthâ€™s all-time highs. If a market correction is defined as a 10% decline from the high, weâ€™re not even halfway there yet. That might feel reassuring in one sense, but it should also mean caution. There could be more weakness ahead if this downturn is going to become a correction, which canâ€™t be ruled out.
The argument against that is there just hasnâ€™t been a lot of interest among investors to really push the market down over the last few months. Every time the SPX dropped to its 20-day moving average since Nov. 1, it met new buyers in what became called a â€œbuy the dipâ€� trade.
This week the SPX actually did fall below the 20-day and then tested the 50-day moving average, which was 3715 heading into Friday (see chart below). The question heading into next week is whether any technical support in that area holds, or if selling picks up. Longer-term technical support is in a range between 3633 and 3695, according to research firm CFRA. This is where the â€œbuy the dipâ€� crowd meets a test: Will they still want to buy the dip after the main crunch of earnings season ends and the world continues to stumble trying to fight the pandemic?Â
The two big numbers to watch could be 30,000 in theÂ Dow Jones Industrial AverageÂ ($DJI) and 3700 in the SPX. The two indices flirted with those levels late Friday, and the $DJI ultimately closed just below 30,000. If it hops back above there Monday and manages to hold on, that would probably be seen as a technical victory that could promise a little recovery ahead.Â
Itâ€™s kind of interesting that all this happened at a time when you could point to some actual positive developments in the background.Â Microsoft CorporationÂ (NASDAQ: MSFT) andÂ Apple IncÂ (NASDAQ: AAPL) both reported earnings that are about as solid as it gets andÂ next week bringsÂ AlphabetÂ (GOOGL)Â andÂ Amazon.com, Inc.Â (NASDAQ: AMZN). Other big names penciled into the earnings lineup next week includeÂ PayPal Holdings IncÂ (NASDAQ: PYPL),Â Alibaba Group Holding LtdÂ (NYSE: BABA),Â United Parcel Service, Inc.Â (NYSE: UPS), andÂ Peloton Interactive IncÂ (NASDAQ: PTON). Weâ€™ll talk more about those reports and what to look for in them on Monday morning.Â
As these companies report, stimulus traction appears to be growing on Capitol Hill. Media coverage this week suggested Democrats might try to speed the $1.9 trillion legislation through Congress through reconciliation, which wouldnâ€™t necessarily require Republican votes. Whatever you might think of the legislation itself, stimulus generally appears to have helped the stock market over the last few months. Next week weâ€™ll see if it elbows its way back into the headlines in a big way, which has potential to be a helpful force for the market.
Volatility Explosion Could Keep Investors Cautious
Whatâ€™s not helpful is the way volatility just exploded this week. On one day, theÂ Cboe Volatility IndexÂ (VIX) skyrocketed to 37 from below 22. This isnâ€™t something you often see, and overall the VIX had its biggest upside week since June.Â
Historically, VIXâ€”sometimes called the marketâ€™s â€œfear indexâ€�â€”trades in ranges over periods of time. It spent a lot of time last fall between 25 and 30, and then early this year between 20 and 25. Now itâ€™s back above 30, and that could indicate more concern about possible choppiness and deeper losses straight ahead. One interesting thing now vs. a week ago, however, is that VIX futures have gone from contango (where outer months are higher than the current level) to backwardation, where the current level outweighs future prices.Â
It was also positive to see the major indices bounce off of their lows late in Fridayâ€™s session, which could have positive ramifications as the new week starts. The SPX at one point on Friday dipped just below 3700, but didnâ€™t seem to find much selling interest down there. One hallmark of last yearâ€™s steep selloff was failure to find buyers late on Fridays who were comfortable holding long positions into the weekend. This sometimes caused late-week selloffs to gain steam. That didnâ€™t appear to be the case Friday, which isnâ€™t a bad thing if youâ€™re hoping for better times ahead.Â
Earnings, stimulus, and vaccination progress all remain key areas to watch as the new week begins. Also, consider closely checking futures market action Sunday night for possible clues about how Monday could open.
Despite Headlines, Vaccine Progress Appears Confirmed This Week
One more thing: JNJâ€™s vaccine data today took some of the blame for the market weakness, but most analysts didnâ€™t think the data was actually all that disappointing. As they said, it appears to be more effective than the flu vaccine we all get each fall, and it also seemed effective in preventing severe COVID-19 cases.Â
The data showed it wasnâ€™t as effective as theÂ Pfizer Inc.Â (NYSE: PFE)/BioNTech SEÂ (NASDAQ: BNTX) andÂ Moderna IncÂ (NASDAQ: MRNA) vaccines already on the market, but few experts had expected that. JNJ was upbeat about the data and analysts said itâ€™s expected to seek quick regulatory approval. Logistically, the JNJ vaccine has a bunch of advantages because itâ€™s a single-injection product that can be stored at much higher temperatures than products made by the other companies.Â
There was also positive vaccine data fromÂ Novavax, Inc.Â (NASDAQ: NVAX) this week, and its shares jumped more than 60% on Friday. The company is considering filing for U.S. approval, news reports said. Which means in a best-case scenario, the U.S. might soon have four vaccines on the market actively fighting against this horrible pandemic. The U.S. government agreed last year to buy 100 million doses of JNJâ€™s vaccine.Â
So maybe those are some things to keep in mind if youâ€™re feeling depressed about how this week turned out.
CHART OF THE DAY:Â FINDING NEW SUPPORT.Â After bouncing off its support of the 20-day moving average (yellow line), theÂ S&P 500 IndexÂ (SPXâ€”candlestick) broke below it on Wednesday and has traded below it since then. Itâ€™s now moved down to its 50-day moving average (blue line) and closed just a hair below it at 3714.18. Itâ€™s too early to tell if this will be the next support level but itâ€™s something to keep an eye on. Data source: S&P Dow Jones Indices. Chart source: TheÂ thinkorswimÂ® platform from TDÂ Ameritrade.Â For illustrative purposes only. Past performance does not guarantee future results.
TD AmeritradeÂ® commentary for educational purposes only. Member SIPC.
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