Modest Decline On Coronavirus Fears
On Friday stocks couldn’t outlast the coronavirus fears like they did on Thursday as the S&P 500 fell 0.9%. The market just avoided a 1% drawdown, as it rallied slightly in the afternoon. There have now been 72 days without a 1% move either way in the S&P 500. Nasdaq fell 0.92% and the Russell 2000 fell 1.35%. And Nasdaq 100 fell 0.82%.
As you can see from the chart below, there have been 17 straight weekly closes without a 1% drawdown in the Nasdaq 100 which is the longest streak ever. It’s tough to say if stocks fell on Friday because of coronavirus fears or just because this euphoric phase needs to end. Stocks are exhausted and are due for a correction. 41 people have died from the coronavirus in China and 1,300 have been infected worldwide.
Volatility Increases & Oil Falls
VIX was up 1.58 to 14.56 as volatility increased modestly because of virus fears/the market being due for a pullback. CNN fear and greed index fell 6 points to 62 as it is on the low end of the greed category. Shanghai Composite index is down 4.46% since January 13th as China is the where the coronavirus first started.
There’s a certain aspect of this decline that’s not related to the virus because oil prices have been falling all year. It seems like the volatility is starting in oil and is slowly spreading to other markets.
As you can see from the chart below, Brent oil is down 13.61% year to date. It’s interesting that oil is falling because there were a few strong Markit PMI reports on Friday which suggested the global economy might be headed in the right direction.
And the solid U.S. Markit composite index hit a 10 month high. Eurozone composite was unchanged, but manufacturing output rose 1.5 points to 47.8 which was a 9 month high. Japanese composite index was up from 48.6 to 51.1 as the services index rose from 49.4 to 52.1.
Yield Curve Continues To Flatten
People are saying the yield curve has been quietly flattening because there isn’t much fanfare over a possible inversion since it already happened. There was way too much hype about the inversion last year as many thought it guaranteed a recession. Now I still follow the curve closely, but I didn’t buy into the recession fears.
As you can see from the chart below, the 3 month 10 year spread has fallen to about 18.5 basis points which is the flattest since December 3rd. The massive rally in the long bond this year signals there will be lower nominal growth. 10 year yield and oil are waving a caution flag while large cap tech stocks are barreling higher. Let’s see if earnings next week bring some of the big cap tech names to their knees.
On Friday, the 10 year yield fell 5 basis points to 1.68%. The yield couldn’t break 1.94% last year, so it lost momentum and reversed. Buying might be coming from abroad as the gap between the 10 year yield and the 10 year bund yield has dropped sharply. 2 year yield fell 2 basis points to 1.49% as the market is shifting further towards expecting a rate cut.
As you can see from the Bloomberg chart below, there is oddly a 12.3% chance of a rate hike Wednesday. That won’t happen. Fed funds futures market has priced in 1.122 cuts in 2020. CME Group FedWatch tool needs to be adjusted as its odds of rate cuts are too low.
Utilities Rally & Healthcare Falls
Utilities sector was the only one up on Friday as it loves the decline in rates. Tesla stock only fell 1.29%, meaning the decline in oil didn’t cause it to underperform sharply. I don’t think Tesla trades off oil anymore. Car buyers buy Teslas because they think it’s a superior car/SUV, not to save money on gas. Their cars aren’t exactly geared towards the budget conscious buyer. It wouldn’t be a big deal for Tesla if it never tried to sell cars for under $30,000 as those have low margins and would hurt the brand.
Biggest losing sectors were the financials and healthcare as they fell 1.36% and 1.68%. Banks don’t like lower rates and flatter curves. That’s partially why the Russell 2000 underperformed. If anything, this virus scare will help the healthcare sector as some firms will profit.
Lakeland Industries, a small cap firm that makes protective equipment for workers in healthcare, has seen its stock rise 25.25% since January 17th. I think healthcare’s decline is more about Bernie’s rise in the polls. Humana and UnitedHealth’s stocks fell 1.84% and 2.22%. They will fall much more if Bernie wins the first 2 state elections. PredictIt Shows Bernie has a 34% chance of winning the nomination and Biden has a 38% chance.
Tech Earnings Are Coming
Big internet firms are reporting earnings next week. Apple reports on Tuesday and Amazon reports on Thursday. Facebook and Microsoft report on Wednesday. Alphabet reports February 3rd. Apple will be the most interesting report because of its unprecedented rally.
As you can see from the chart below, Apple trades at a 28.8% premium to the S&P 500 but only has a 7% forward EPS discount compared to the S&P 500’s 13% discount. Apple’s enterprise value to forward net income multiple hasn’t been this high since October 2009.
The stock market fell on Friday in part because of the coronavirus and in part because stocks needed to expunge some of the euphoria expressed by investors. Oil and the long bond are showing signs of cracking, but stocks have been resilient, especially the big cap internet names.
Let’s see if their reports this coming weak catalyze a correction. Apple is quite expensive, so if it misses estimates, it’s stock can fall precipitously.
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