Investors, it's time to buckle up

Dow suffers biggest point loss in over 6 years

You know it's a bad day on Wall Street when the talk isn't about tech sector earnings, impressive GDP growth estimates or solid job market progress that's finally pushing up wages.

Instead, it's all about the biblical warning of the "Mark of the Beast," given the Dow Jones industrials ominous loss of 666 points on Friday -- the worst point decline since Lehman Brothers collapsed in October 2008. The 2.5 percent tumble was the worst percentage drop since the Brexit vote in June 2016. And it capped the worst week for stocks since January 2016. All coming on Federal Reserve Chair Janet Yellen's last day at the helm of the U.S. central bank.

The losses even deepened after the close, to 729 points on Dow industrials in Friday's after-hours trading. As of around 8:45 a.m. Monday moring, the losses are continuing in stock index futures trading, with the Dow futures down more than 170 points.

In the context of the perfection that has been the post-election uptrend -- with stocks enjoying a historic, no volatility rally -- the selloff was jarring. And its cause, an accelerating surge in long-term interest rates, is a big deal. The 10-year Treasury yield has pushed up to 2.8 percent from 2.4 percent at the end of 2017 (chart below). 

The selling was catastrophic with no midday rebound, no dip buyers and no silver lining heading into the weekend. Decliners outpaced advancers by  9 to 1, and all 11 major S&P sector groups closed in the red.

The dramatics continued after the close as Yellen, on her way out the door, slapped Wells Fargo (WFC) with regulatory action over it governance. The Fed announced it would restrict the bank's growth until the situation improves -- tantamount to a soft nationalization. Yellen also expressed disappointment over the weekend that President Donald Trump didn't give her another term and warned that asset valuations are elevated (but didn't want to call the situation a bubble).

It's no coincidence that Yellen waited until her last workday to engage in the macroprudential actions she has long said were the preferred tools to lean against asset bubbles. Feels like a mic-drop moment -- or a middle-finger moment. Maybe both, in an angry parting shot to President Trump.

The good news: Stocks are oversold in the short-term and due for a relief rebound. The bad news: The resulting bounce could be one of the last exit opportunities ahead of what's likely to be deeper declines as the cost of credit continues to rise.

Friday's jobs numbers fit into that thesis. Payrolls grew by 200,000 vs. the 175,000 expected as the unemployment rate held steady at 4.1 percent. But average hourly wages increased to a 2.9 percent annual rate, up from 2.5 percent prior and the 2.6 percent analysts were expecting -- raising the specter of wage-push inflation.

Remember as Yellen exits, and Jerome Powell take the helm, it's becoming clear the Federal Reserve is behind the curve on policy: Since the Fed started raising interest rates in 2015, financial conditions have actually grown more and more easy. Something similar happened before, in the midst of the mid-aughts as the housing bubble was roaring. It didn't end well when the Fed finally clamped down.

Moreover, there are the ongoing political machinations in Washington over Russia's involvement in the the presidential election, a looming government shutdown deadline -- and the debt ceiling coming up again in March.

But first, that possible relief rebound.

Jason Goepfert at SentimenTrader ran the numbers a bunch of different way. And they look all look good. Viewing the S&P 500 after a four-standard deviation selloff (which is what Friday was, amid low volatility) within a week of a new high? Stocks were higher a month later 90 percent of the time. The S&P 500 suffering its worst week after a new high? The index was higher one month later 100 percent of the time. After ending a long streak without a 3 percent pullback? Again, higher three months later 73 percent of the time.

Moreover, Friday featured record trading volume in inverse ETF products that win when the market loses (a positive contrarian signal). And the McClellan Oscillator, a measure of market breadth, fell into deep oversold territory.

Summarizing, Goepfert outlines a scenario based on market history: "Very generally, the pattern after most of them was a rebound in the very short-term, meaning the next week or so, another decline that tests the panic low (likely exceeding it), then a consistent rebound over the next three to six months."

What comes after that? A further increase in interest rates as the economy heats up, putting the three-decade bull market in bonds on notice. Buckle up. 

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