Rates, Inflation or The Memo?

This article was originally published on Nadex.com.

Stocks just had their worst week in 2 years. On Friday, the S&P 500 ended down almost 60 points, the Nasdaq Composite down almost 145 points and the Dow Jones Industrial Average just under 666 points (with the Dow Futures ending lower by 729 points). While the Dow is still up 3.2% on the year it is now down 4.1% from its all-time highs reached just a week ago. Similarly, the Nasdaq Composite is up 4.8% year to date (YTD) but down 3.5% from the highs and the S&P is still up 3.2% YTD but down almost 3.9% from the highs. Often times it takes a big event to shift a market tone so quickly and considering this selloff happened on a Friday, we really don't know yet if it's going to extend, but certainly, people were acting as if the end of the bull run was near. After years of analysts (including us) stating "the market needs a healthy correction", it sure didn't feel healthy while it was happening. 

There were really 3 events that converged Friday to cause the fall to be so dramatic. The market was already weak with the S&P having been down 3 of the last 5 days after the strongest January since 1997. The monthly non-farm payrolls release added to that pressure as average hourly earnings growth jumped year over year to a 2.9 increase, fastest in 3 years. This pushed the narrative that inflation could be heating up which drove treasury rates higher, with the 10-year note hitting it's highest yield in 4 years. The odds of an FOMC rate hike at the next meeting in March also rose from 76% to 77.5%. Stocks then went sideways and even recovered a bit until the Nunes memo was released, suggesting partisanship and anti-Donald Trump bias in the assumed unbiased institutions of the FBI and the Justice Department. Stocks fell apart and never recovered. 

The idea that one of these 3 factors is responsible for the "number of the beast" decline we saw in the Dow and as well as the falls in the Nasdaq and S&P is way too simple. It's more likely that the 3 of these items combined with what was probably the most important factor, the fact that this trilogy occurred on a Friday, was the cause. Considering the vitriol between parties and branches of government that we are living through and considering that we are due again for a budget-continuing resolution-government shutdown debate, one does not want to be buying a dip of this magnitude on a Friday afternoon. This was a lack of buyers price collapse more than it was a panic sellers price collapse. The best thing about markets to me has always been that markets may pose questions, but they always give us answers to those questions. I suspect the rise in longer-term rates is the more important factor in weak equity prices, with inflation second and memo-gate third, but we will find out. whatever it is, remember 3 things; the first is an investing rule we posted in an article on January 17th, from 78-year market veteran Bob Farrel. "Exponentially rapidly rising or falling markets usually go farther than you think, but they do not correct by going sideways." The second is that everyone wanted and was looking for a healthy correction. Now let's see if anyone has the courage of their convictions to buy it. Lastly, January was a strong month and the January effect has a great track record (see chart).

 

According to the Stock Trader's Almanac, the previous 29 times since 1949 when stocks were up in January, rose in the first five days of the year and rose during the “Santa Claus rally,” a seven-day stretch that ends Jan. 3., the S&P 500 rose 26 times, or 90% of the time, in the final 11 months of the year. The average gain was 12.9%. It's not the time to panic yet, although as always "Past performance is not a guarantee of future results".

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