The S&P 500 plunged -4.78% this week with Friday's close at 3,041.31.
I played baseball from the age of 5 through my freshman year of high school, and I can't tell you how many times I struck out because I thought I was swinging at a fastball, but the pitch was actually a curveball. The price action this week was a nice curveball...
The S&P 500 came into the week having increased 4.91% the week before, and by more than 3% for each of the prior three weeks, something we've rarely seen over the last ~70 years. We wrote about how three-week winning streaks that saw the index gain 10% or more were mostly smooth sailing over the weeks ahead - except for the most recent sample where the S&P 500 got "absolutely smashed the next month." Well, what used to happen over months now happens over weeks in 2020, so naturally the S&P 500 got absolutely smashed this week. The right answer was exercise patience and adhere to a disciplined process and not to "panic buy Monday's open".
While we can't say we're all that surprised to see the S&P 500 trade back below 3,000 (we wrote last week that "we find it hard to believe that the S&P 500 won't trade below 3,000 again at any point during the remainder of 2020"), we're very surprised it only took four trading days from last Sunday's Update for the S&P 500 to trade back below the 3,000 marker. Our guess is the "FOMO" we discussed last week has dissipated, at least by a little bit.
The S&P 500 traded up to 3,233.13 on Monday, and was trading at 3,223.27 on Wednesday, only to then decline by -6.94% in a little over 24 hours, falling to Thursday's low at 2,999.49. On Friday we then saw the S&P 500 trade up by nearly 3%, rising to 3,088.42 in early trading, only to then decline -3.36% into Friday's low at 2,984.47. The index would then find buying interest into Friday's close, gaining 1.90% from Friday's low to Friday's close at 3,041.31. The volatility was dizzying and is another reminder of how "broken" modern markets have become. What used to happen over weeks now happens over days, and what used to happen over months now happens over weeks. Price is moving fast, definitely faster than our liking, and it doesn't appear interested in slowing down any time soon.
Over the last 5 years, the S&P 500 has developed a propensity to price as if there's an on/off switch. We've seen upside extremes or time periods where the S&P 500 is turned "on", such as a 15-month winning streak for the S&P 500 Total Return Index from late 2016 into early 2018, and the most recent linear stampede higher from March of 2020's low. We've seen plenty of downside extremes too, or time periods where the S&P 500 is turned "off", such as February 2018's correction, the fourth quarter of 2018's crash, and now the first quarter of 2020's crash. The old phrase "it's not your father's market" has never been more applicable, and over the short term the question now is...did the S&P 500 just turn off again?
To be frank, we have absolutely no idea at this point. This is now the third sharp, fast, and violent selloff we've seen since bottoming in March. In April the S&P 500 declined roughly -5% over 2 days, in May the index fell -6% over 2 days, and now here in June we have a -7.5% plunge over 2 days.
The uncertainty lies in what happens next. Since March, every single dip we mentioned above was bought with reckless abandon as if the two-day sale was the deal of a lifetime. It took the S&P 500 just 4 days to recover all that was lost in April and just 2 days to recover the entirety of the -6% decline in May. Interestingly, the excessive speculation we wrote about in last week's Update was completely unfazed by this most recent two-day selloff. Small traders plowed into call options and disregarded put options on Friday, an explicit bet on higher stock prices, the likes of which we've never seen before.
We find it completely unreasonable to believe the S&P 500 will recover all of this week's 7.5% decline over "days", but it obviously can't be ruled out given what has transpired since March.
We don't know what's coming this week, nobody does, but if we had to guess we'd at least be of the opinion that the S&P 500 trades below 2,984.47 at some point over the week ahead. We're less certain about whether the index will then stay there, or close the week back in the 3,000s.
Referencing back to the chart we've been sharing lately, the picture and narrative is now that of past resistance becoming future support. The S&P 500 has retraced back to the area where it broke out, which coincides with our 200-day moving averages (both simple and exponentially weighted) and the 61.8% Fibonacci retracement calculated from February's peak to March's low. The 50-day simple moving average is also at 2,903.24 and ascending. Trading down into the ~2,900-2,950 region would mark at an obvious area of meaningful "support" over the week ahead.
Thinking about the weeks ahead (plural), we can also identify potential levels of support based on calculating Fibonacci retracement levels from March's low into June's high (red lines on the chart above). That would leave the 38.2% retracement at 2,837.05, a level that's essentially right in the middle of April and May's traffic jam, and the 50% retracement at 2,713.85, a level we believe participants will be very, very eager to buy given both April and May's lows. We believe it's likely we'll trade into the low 2,700s before the summer is over.
Finally, the S&P 500 finished this week higher by 31.95% the last 12 weeks, after having declined -28.86% the prior 12 weeks. I suppose we can also say that what used to happen over years now happens over months. We share this to explicitly state that we have absolutely no idea what lies ahead for the next 12 weeks. We're mired in an unprecedented climate, one that pits never seen before stimulus from global central banks and governments throughout the world against a never seen before global pandemic that has caused more damage to the global economy than any other time period since the Great Depression...with forward-looking uncertainty higher than we've all ever seen. This is causing unprecedented price action for the S&P 500 and this week was yet another example.
The last two weeks have seen the index gain 4.91% and then lose -4.78%, which leaves the S&P 500 down -0.10% over the trailing two weeks. Since 1970, we've seen the S&P 500 gain 3% or more for a calendar week - and then give it all back the very next week (i.e., decline enough to evaporate the prior week's 3% advance) a total of 8 previous times (this week marks the 9th instance). In all prior instances, this occurred with the S&P 500 in a downtrend, meaning its trailing 4-, 8-, and 12-week returns were negative. In this instance, this occurred with the S&P 500 in an uptrend, meaning its trailing returns over the last 4, 8, and 12 weeks are decisively positive. We've never seen this happen before. Yes, never.
The Volatility Index (VIX) finished the week at 36.09, suggesting the S&P 500 trades higher or lower by within 5% over a calendar week. In other words, buckle up and have nothing but humility as to what lies ahead for both next week and the next 12 weeks.
S&P 500 Primary Trend - Neutral
The S&P 500 started the month of June by gaining 6.18% the first 6 days of the month - and it gave it all back the last 4 trading days. June just pushed the reset button, we're starting over, and to say the remainder of the month is pivotal is an understatement.
A negative close for the month would leave the narrative as the S&P 500 facing meaningful resistance at the ~3,230 price level, which just so happens to be the year-to-date flat line, and not finding meaningful buying interest from this past Friday's low. Alternatively, a monthly close back at, above, or near ~3,230 and clearly the S&P 500 found meaningful buying interest from somewhere, whether Friday's low or a lower low. In defining the primary trend, there would appear to be valuable information in the price action the remainder of the month.
For long-term investors, the time frame is generally months or years, and our work/model continues to believe a balanced and diversified asset allocation is the most prudent approach.
Referencing back to the analogy used earlier, we're witnessing a fight between unprecedented global stimulus via aggressive monetary and fiscal policy versus a severe global economic recession. Without knowing who the winner will be, it's imperative long-term investors position portions of their portfolio to thrive in either scenario, rather than allocating 100% of their portfolio toward one particular outcome.
It's quite clear that stocks, or equities, stand to gain the most in the event stimulus is truly able to defeat the recession, and it's quite clear that fixed income and precious metals will win the most in the event stimulus can't control the path of the global economy. There's huge risk and huge reward in allocating 100% of your portfolio toward one particular outcome, whether 100% to stocks or 100% to a combination of bonds and gold. It's like betting your entire bankroll on black; you're going to lose big most of the time. Given the uncertainty in the outcome of the fight, this doesn't seem to be a prudent, defensible, and intelligent decision for a long-term investor to make.
Instead, it's best to align your portfolio with the uncertainty that exists in the outcome of the fight. A willingness to put some money on both red and black, and preserve your bankroll, always optimizes your probability of better outcomes over time, especially when you truly have no idea what the outcome will be.
Importantly, this is not always the best approach to take. In climates with less uncertainty, drastically over-weighting one asset class relative to the other is often the best course of action (until greater uncertainty appears). But now is not one of those times, unfortunately. It's no time to be swinging for the fences; rather, it's time avoid striking out by respecting uncertainty and striving to smooth returns in an intelligent and defensible manner.
It's as certain as death and taxes that the sunshine will return, the clouds will clear, we're just not there yet. Invest accordingly.
S&P 500 - The Army Gets Clobbered
Each of our last two Updates have discussed the relative performance of two versions of the S&P 500: the less well-known equally-weighted version of the index (SPXEW) and the more well-known market capitalization-weighted version of the index (SPX).
The story the last few weeks has been the return of equal weight, with SPXEW absolutely exploding to the upside. Well, if there's another lesson in 2020 it's that the faster they rise, the harder they fall, and vice versa. SPXEW declined -7.56% this week, underperforming SPX by -2.92%. That's the 4th worst weekly performance of SPXEW relative to SPX that we've ever seen. Ironically, this follows the prior week's gain of 4.50%, which is the single greatest week of outperformance SPXEW has ever produced relative to SPX.
Certain areas of the market were absolutely decimated this week. The S&P 500 energy sector declined -11..07%, the S&P 500 financial sector declined -9.32%, the S&P 500 materials sector fell 8%, and the S&P 500 industrial sector fell -8.03%. It was the technology show this week, with the S&P 500 technology sector losing just -2.03%. However, the technology sector left a precarious U-turn on the charts...reversing lower right from a shade above its all-time high at 1,804.18. We call this an "oopsie" pattern, and it reminds us of the old phrase "from false moves comes fast moves".
So, the Lebron of the market went cold this week and the rest of the team shot airball after airball. The technology sector hasn't recorded a two-week losing streak since March, and the rest of the team is face-to-face with "support".
We've gone from a "breadth thrust" to a "breadth bust" in the span of two weeks. We'll be watching to see if Lebron can start hitting his shot again (i.e., technology avoiding a two-week losing streak) and if the rest of the team can find a way to contribute (i.e., SPXEW finding relative strength).
Bonds & Gold Follow-Up
In last week's Update we made the case for both bonds and gold performing positively over the week, and this came to fruition. The 30-year United States Treasury bond gained 2.71% this week on the heels of the Federal Reserve essentially announcing there will be no interest rate increases through 2022.
The yield curve also collapsed exactly where we thought it would. We wrote that:
"With the short end of the curve anchored to 0%, it would seem as good a time as any for participants to bid 10-year United States Treasury bonds."
They certainly bid 'em. The yield curve (10-year Treasury bond yields less 2-year Treasury bond yields) collapsed by -24.64% this week this week. Updated chart is below.
Lower rates across the curve helped gold get a boost this week. Gold climbed 3.23% this week with Friday's close at $1,737.30.
It was a pivotal week for both bonds and gold, and both pivoted to the upside. The primary trend for both asset classes remains up, or "bullish", and most investors are best served including an allocation to both within their asset allocation.
In any scenario where the future isn't perfect, meaning the fear of COVID persists, consumer spending remains suppressed, and there is a return to a new normal that's a good bit different than the old normal, it's highly likely both bonds and gold will deliver positive returns to offset the volatility in the stock market. That's one of the ways you can win by losing less.
Steve & Rick
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