After a high opening, stocks went for a nosedive led by a small group of tech and health care stocks. There could be a few different issues to blame, but the buzz in the financial press suggested that investors are nervous about the details of the U.S./China trade deal.
It may seem somewhat confusing to have traders selling the stocks that stand to benefit from a deal that includes protection for intellectual property rights in China. However, I think investors have priced in their estimates for those gains already. Stocks are largely priced based on what investors think about the future, not what is happening today.
The old trader adage "buy the rumor sell the news" is true because traders must make estimates about the future and tend to overprice the unknowns. In other words, the closer we get to seeing the terms of a deal, the more likely it will be that investors will have overestimated its value.
Technical analysts have used this phenomenon to great effect by building strategies that short stocks after a big news event, or they exit long positions just before new information is released. When those events coincide with a major technical resistance level, the effect can become even more profound, which is likely the biggest concern among traders right now.
However, I think it is important to note that today's range doesn't look like a panic, and a retracement at this level would be normal compared to historical trends that reached similar extremes. I think the most important takeaway from today's market action is that 2,800 on the S&P 500 is unlikely to be breached without either a retracement back to support (perhaps 2,650 range) or an unforeseen event that significantly changes the short-term outlook.
Risk Indicators – Dollar's Bigly Strength
Most risk indicators remained stable today despite the selling in the mid-session. Junk bonds held at their own resistance level, while emerging markets and commodities traded flat. It was virtually impossible to find any serious signs of stress except within a small group of tech and health care stocks.
There was some buying in the U.S. dollar, which continued to rise after Friday's spike, and this may be of some concern. The move happened despite President Trump's comments at CPAC over the weekend that the dollar was too strong. I have to agree with Mr. Trump on that score, and I thought there could be some deterioration in the dollar's trade-weighted value today following those comments; that didn't happen.
In the past, comments from a U.S. president, Treasury secretary or Fed chairman about a weak dollar would have had exactly the opposite effect. For example, when Treasury Secretary Steven Mnuchin said that a "weaker dollar is good for us as it relates to trade" on Jan. 24, 2018, the greenback lost 1% against its biggest trading partners the same day.
In my opinion, the dollar's defensiveness today reflects some stress in the market over the trade unknowns. As you can see in the following chart, the dollar has now retested its double bottom breakout in February and could hit the previous target again. For convenience, I have used a chart of the Invesco DB Dollar Bull index ETF (UUP), which tracks the dollar index futures closely.
Bottom Line: A Busy Week Ahead
This is a big week for fundamental data. There are still a number of key earnings reports due from retail companies like Target Corporation (TGT) Ross Stores, Inc. (ROST) and Dollar Tree, Inc. (DLTR), and labor data will be released on Friday.
The labor report should be interesting because the last two releases were so far above expectations. In the past, I have observed that, when the Bureau of Labor Statistics’ (BLS) report is underestimated by the kinds of margins we saw in January and February, the subsequent month's report includes a large downward revision in the prior statements.
I suspect that this underestimate-revision cycle is due to changes made to the BLS's seasonal adjustments in its calculation, and this can increase the risk for a market disruption once the data arrives. In this case, I expect that a large revision would push long-term interest rates and stocks lower and Treasury bonds higher. If the S&P 500 is still at or below resistance by Thursday's close, I would assume that short-term traders will be applying some risk control before the BLS report is released.
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