/ December 19
Daily Briefing
*Yesterday marked a disappointing session for all risk assets; the S&P 500 slid -2.95%, the Nasdaq Composite was -3.5% lower, and the Dow Jones Industrial Average closed more than 1,100 points lower (-2.58%), logging its tenth consecutive decline; bonds, gold and commodities also declined, with the U.S. dollar being the sole asset class in positive territory;
*The major indices traded slightly higher until selling picked up at 2:00 ET as investors grappled with the likelihood that the Fed will be pausing its rate-cut campaign and that rates are going to remain higher for longer; this understanding followed the FOMC's decision to cut rates 25 basis points to 4.25-4.50%, as expected; it was not a unanimous vote, however; Cleveland Fed President Hammack dissented in favor of leaving the target range for the fed funds rate unchanged at 4.50-4.75%;
*Additionally, the median estimate for the 2025 fed funds rate was bumped up to 3.9% from 3.4%, signaling an outlook for only 50-basis points of easing in 2025 versus 100-basis points when the September projection was released;
*SPY recorded the largest 1-day price move of the last 2 years and crashed below support at the 50-DMA level; interestingly, the benchmark equity ETF is not yet “oversold” according to our medium-term measure, recording a value of 44 / 100; now, the focus turns to weather the correction is complete (and a break above $596 is realized) or more pain follows; technically, the next support level is a ways away below the last price, near the 200-DMA and S1 level in the $540-$550 ballpark (-7.8%); normally, fundamentals don’t support such an extreme drawdown — but that doesn’t mean it can’t occur on supply/demand dynamics alone;
*The MACD signal is now recording a negative divergence which has only been surpassed 3 times in the last year, during the November, August and April correction episodes; it should be noted that in 2 of these 3 instances, the subsequent positive crossover occurred in the lower part of the histogram chart (sub-0 values), and we are far from reaching that part currently;
*Our sentiment measure has reached “Extreme Fear” readings, as denoted by the score and the number of individual stocks oversold (at 2-standard deviation highs); it should be noted that this indicator tends to spend some time in its “Extreme” zones, and shouldn’t normally bounce in a single session; nevertheless, for those investors concerned about not having enough exposure to the equity market, this is certainly a favorable moment to make additions;
*From a fundamental perspective, there is now enough upside to satisfy the equity risk premium of holding stocks versus bonds; the 10-yr yield, which is most sensitive to changes in inflation, jumped 11 basis points to 4.49%; the 1-year yield, most sensitive to changes in the fed funds rate, stands at 4.3% currently;
*Whichever measure an investor uses to determine the necessary return on investment matters little; the rule of thumb is to add 4% to the risk-free rate, which in this case results in a required return of 8.3% to 8.5% for holding stocks;
*In our Market Outlook for 2025 we stated:
Normally, we would be looking for around 8% upside to our base-case price target in order to remain fully invested. That implies a $592 or below “buy-the-dip” target for SPY.
*From a fundamental perspective and assuming our base case scenario remains valid, adding to equity exposure at this juncture now makes sense; there is more upside than downside available;
*However, as we also noted in our December 02 Weekly Preview titled “Signs of Speculation”, inflows into high risk levered products was becoming extreme; fund Manager cash allocations were at record lows just a couple of trading days ago; whoever can push the market higher needs liquidity (cash) in order to do so; if everyone is “all in” — who’s left to buy?
*Dollar transaction volume sits very close to record highs, which denotes “liquidation” when viewed through the lens of an aggressive sell-off; spikes in volume (positive or negative) are usually associated with the end of liquidation events, not the beginning;
*In any case, volatility has spiked, along with the cost of hedging; both the VIX index and the VVIX (volatility of of the VIX) are now recording elevated levels;
*Conclusion: this is now a decent “buy-the-dip” opportunity in all risk assets, for under-allocated investors; however, it should be noted that there is the potential for more downside in the medium term; we could see the market rally and fail at $596 - $600 resistance; until the dollar transaction volume settles down and sentiment spends more time reading “Extreme Fear”, we would be hesitant in giving the “green light” to full blown risk taking;
*In our live portfolio, we will postpone necessary selling until we get a reflexive rally; we will start to execute some buys, but nothing extreme;
*The bond market also reacted strongly to the notion that rates may remain elevated if inflation remains sticky above the Fed's 2.0% target while the labor market remains strong;
*TLT fell -1.25% and closed below our designated stop-loss level; the next level of support sits close by, at $88.5 (S2), so potential downside is much lower for bonds than for stocks;