Dr. Duke's Blog
Do you know any trading coaches who publish the results of their trades daily? Dr. Duke posts the trading track records of his Flying With The Condor™, Conservative Income, Dr. Duke's Trading Group, and The No Hype Zone Newsletter services in the free downloads section of this web site. If you have questions about any of the trades, Ask Dr. Duke.
Civilization Is Under Siege
- Written by Dr. Duke
The Standard and Poor’s 500 Index (SPX) opened this week at 3155 and closed today at 3185 for a rise of nearly 1%. On Thursday, SPX’s 50 day moving average (dma) finally broke above the 200 day dma at 3021. A basic sign of recovery for a stock or an index is when the 50 dma overtakes the 200 dma. The S&P 500 remains nearly 6% underwater from the March correction. Trading volume for the S&P 500 companies has been running very low for the past several weeks. Today’s trading volume at 2.4 billion shares was well below the 50 dma at 3.1 billion shares. Today was the ninth trading session in succession with trading volume running below the 50 dma. I interpret this as general apprehension on the part of traders. We’re nervous about what tomorrow brings, and we are keeping a lot of cash on the sidelines. It is difficult or impossible to analyze what price makes sense for this market, given the extensive damage done by the shutdown. It is difficult to have the confidence “to go all in.”
VIX, the volatility index for the S&P 500 options, closed today at 27.3%. The recent low was 24.5% on June 5th. It may be hard to remember in the midst of this chaos, but volatility was running around 12% back in January. The current levels of volatility serve as a reminder that this remains a dangerous market.
IWM, the ETF based on the Russell 2000 group of companies, traded lower this week, closing Friday at 141.31, down 2.8% on the week. IWM bounced off of its 50 dma at 137.30 yesterday. Weakness in the small to mid-cap stocks has always been a reliable indicator of the market’s acceptance of risk. Like many of our citizens living in fear of the coronavirus, many traders are hiding under the bed, afraid for their investments.
The NASDAQ Composite index closed today at 10,617, a new all-time high for this index. NASDAQ gained 2.5% this week alone. Since June 29th, NASDAQ has been trading nearly straight upward, a run of 8.7%. But trading volume has been running below the 50 dma over this entire bullish run. This reinforces what we see with trading in the S&P 500.
I freely admit that I do not understand this market. Why is it possible that the NASDAQ composite has now set a new all-time high in the midst of the most severe (and self-inflicted) economic damage this country has seen since the Great Depression? Add in the rioting, looting, murder, and arson we are seeing in all of our major cities. Even more surprising, in almost every case, our government has stood by helplessly and allowed the mob to burn our cities, tear down statues, and even usurp public and private property and declare a new state. Many mayors and governors even defend the mob. The rule of law is not being enforced. Our very civilization is being threatened. But you wouldn’t know that from watching the NASDAQ hit new highs. The son of an acquaintance asked his dad why Costco was open, but they couldn’t go to church. Children often see the obvious that adults somehow miss.
You may disagree with my view of current events. A common response once was, “It’s a free country”, but it is now dangerous to express your views. Our civilization and our freedom are under siege. The S&P 500 remains 6% below its pre-correction highs and the Russell 2000 is 16% below its pre-correction highs. This week’s unemployment data improved but eighteen million remain on the unemployment rolls. I certainly wish the best for our leaders as they attempt to resurrect our economy. However, it is going to be a long, hard climb out of this hole.
The risk of this market is most succinctly illustrated by the current levels of volatility. Higher levels of implied volatility also communicate higher risk. As many of you know, the most conservative stock and options trade is a covered call on a blue-chip stock. My Conservative Income trading service has been using those trades this month and we are now up 3.7% for the month and up 13% for the year. You wouldn’t know we had a severe market correction. Those are better than average returns for this type of trading. Those elevated returns are a direct result of the higher levels of volatility that drive higher option prices and higher returns for this conservative style of trading.
The bottom line: It isn’t necessary to continue to hide under the bed from a financial viewpoint. We only took a 10% loss in March when the market lost 35%. And now we are up 13% year to date while the market remains down 6%. That is called risk management. Carefully weigh the risks of this market. Set tight stop losses and follow them with great discipline.
Surviving the Correction
- Written by Dr. Duke
The coronavirus correction in March took the stock prices of the S&P 500 companies down by 35%. Ouch! How did your portfolio do? As many of you know only too well, the damage isn't over. The S&P 500 remains 8% underwater.
The perennial argument is Buy and Hold vs. Timing the Market. The Buy and Hold camp tells us that it is impossible to sell at the highs and buy back at the lows. Perfect market timing is impossible, but open a price chart of the S&P 500 index. It was obvious to everyone by the last week in February that the market was in serious trouble. Depending on when you started closing positions that week, you would have limited your losses to something on the order of 10-12%.
But the Buy and Hold crowd rode the market down to the 35% low on March 23rd. And those portfolios have still not returned to positive territory. Many investors are afraid to see how badly they have been hurt and are just not opening their accounts. The Buy and Hold crowd became the Hiding Under the Bed crowd.
Some will argue this is a matter of risk. Conservative investors have been told that actively trading their stock portfolio is a high risk game. The results year to date in two of my trading services, each of which mirror my portfolios at Charles Schwab and E*Trade, serve as excellent real life examples.
The Conservative Income trading service mirrors the covered calls and cash secured naked puts in my E*Trade account. When used with solid blue chip stocks, these are widely regarded as the most conservative stock and option trading strategies available to the retail investor. When the market lost 35% in March, this service lost 10%. One month later, this portfolio had returned to break-even for the year. As of today, the year to date returns for investors in this portfolio is +13%, while the S&P 500 is still down 8%. This portfolio takes low risk positions and survived the correction very well. Taking more risk isn't necessary to protect your portfolio from corrections in the market.
Dr. Duke's Trading Group uses a variety of option spreads that incur moderate to high levels of risk. Our low point during the March correction was -36%, approximately the same as the overall market. But that is where the similarity ended. This portfolio had returned to break-even after six weeks. Year to date, our trading group has gained 132%. Members of this group are certainly taking more risk, but they survived the correction very well.
Whether an investor uses conservative, low risk trading strategies or chooses to incur higher levels of risk doesn't affect the trader's ability to survive a correction.
The difference is risk management.
Conservative trading strategies lead to a tighter spread of wins and losses, i.e., the standard deviation of the results is smaller. The average gains over time will be positive if trades are managed well. But these trades take less risk and therefore result in smaller net gains over time.
Trading strategies that incur higher risk lead to a wider spread of wins and losses, i.e., the standard deviation of the results is larger. But, again, the average gains over time will be positive if trades are managed well. One of the fundamental laws of finance tells us that the potential of higher gains is always accompanied by higher levels of risk. The higher returns of the trading group are an excellent illustration of that principle.
The crucial learning here is that the level of risk you take in your trading does not affect the ability of your portfolio to survive a correction. The ability to survive the correction is rooted in risk management:
• Choose trading strategies consistent with your risk profile.
• Learn as much as you can about the trades you choose to employ.
• Trade small. Trading small gives you the time to build experience without losing the farm.
• Develop and follow a trading system, i.e., a system of rules for entering, managing, and exiting each trade.
• Both greed and fear are dangerous emotions. Your trading system is the cure.
If you are tired of watching your portfolio swing back and forth in these volatile markets, check out the private coaching and group classes offered by Parkwood Capital. Subscribe to the Conservative Income service or Dr. Duke's Trading Group. If you aren't happy at the end of one month, we will refund your subscription.
Happy Independence Day!
Is the Market Approaching Equilibrium?
- Written by Dr. Duke
The Standard and Poor’s 500 Index (SPX) opened this week at 3094 and declined through the week to close Friday at 3009, down 2.7%. Friday’s trading broke the 200-day moving average (dma) at 3021. Roughly speaking, this brings SPX back to where we were about a week ago. Friday’s close is 11% below the high prior to the correction. Personally, I think that represents an extremely optimistic assessment of the economic damage. Trading volume for the S&P 500 companies has generally run below the 50-day moving average (dma) over the past two weeks. I am unsure why trading volume spiked so much yesterday. The spike last Friday was due to quadruple witching, but yesterday’s spike is puzzling.
VIX, the volatility index for the S&P 500 options, which had declined since the peak of the correction, spiked up to 43% on June 11th and closed Friday at 35%. We may be becoming numb to these levels of volatility, but it is worth reminding ourselves that these are historically high levels of volatility. This remains a nervous, and therefore dangerous, market.
IWM, the ETF based on the Russell 2000 group of companies, traded lower this week, closing Friday at 140.24, down 2.6% on the week. IWM broke down through its 200 dma on June 10th and is now approaching its 50 dma at 134.01.
The NASDAQ Composite index tumbled Friday afternoon, losing 260 points to close at 9757, down 1.9% for the week. Perhaps more significantly, NASDAQ surrendered its pre-correction high at 9817 on Friday. This week appeared to be the splash of cold water on the strong bullish trend since the correction lows in late March. It remains difficult to explain why the NASDAQ composite should be valued higher than it was in February after all of the economic damage done by the coronavirus lockdown of the economy. I don’t have hard supporting data, but I think the market pricing that corresponds to the current state of this economy is lower yet.
The S&P 500 is now 11% below its high on February 19th. This week’s unemployment data reported twenty million continuing unemployment claims. How can we have twenty million unemployed and yet value the S&P 500 companies only 11% below the pre-correction high? The media have continued their push to fuel the panic. Have you noticed the shift in emphasis? Since the beginning of the pandemic, the evening news always led with the number of covid deaths and projections of an eventual death toll of two to three million and mortality rates of 10% or more. Now the headlines focus on the number of covid cases, which are increasing as testing becomes more widely available. The mortality rate is now on the order of 0.2% or less, more in line with a serious flu season. And the inconsistencies abound. Our governor thinks it is perfectly acceptable to walk shoulder to shoulder with protesters without a mask but continues to order churches closed.
Regardless of how you view the current events, the high levels of volatility drive higher option prices and offer trading opportunities. On the other hand, higher levels of implied volatility also communicate higher risk. Allow me to illustrate with one example from this week. On Thursday I sold the COUP Jun(6/26) 270 call for $715 and then rolled out to Jul(7/2) on Friday for a credit of $618. I collected $1,333 in two days on an investment of $25,718. Of course, next week could bring a very different story – that illustrates the pros and cons of this trading environment.
Carefully weigh the risks of this market. Set tight stop losses and follow them with great discipline.
- Written by Dr. Duke
The Standard and Poor’s 500 Index (SPX) opened this week at 3200 and continued to trade higher through Wednesday but then the long recovery came to a stop. SPX closed today at 3041, for a 5% decline just this week. Thursday’s trading broke the 200-day moving average (dma) but the index opened higher today and closed well above the 200 dma. Trading volume for the S&P 500 companies has been choppy for the last two weeks, running along below and just above the 50-day moving average (dma).
VIX, the volatility index for the S&P 500 options, had declined since the peak of the correction, and reached 24.5% last Friday, matching lows from late February. VIX moved higher this week and spiked as high as 43% on Thursday. VIX closed today at 36.1%, reminding us that this remains a nervous, and therefore dangerous, market.
IWM, the ETF based on the Russell 2000 group of companies, closed at 138.27, up 3.24 points today, but closed the week with a 9.2% decline. As usual, the small to mid-cap stocks in the Russell 2000 trade lower faster whenever traders get spooked.
The NASDAQ Composite index tumbled Wednesday and gapped open lower Thursday for a large loss. NASDAQ closed at 9589, up 96 points today, but lost 2.4% for the week. NASDAQ continues its role as the broad market leader, recovering its pre-correction high this week, but taking less of a hit as the market sold off over the past two days.
This was an interesting week in this trip back from the correction. The first surprise is how NASDAQ actually tacked on gains over the pre-correction highs. How does that make any economic sense? Even today’s close remains just below the previous highs.
I don’t think anyone has sufficient data to even roughly estimate where the market averages should settle after this man-made recession. So all we can do is trade what we see and have a bias toward the high-tech stocks that seem to have some immunity to the market damage. This week’s trading reminded us that this market will continue to be quite volatile. We closed our INTC trade this week for a 63% gain, but our AMD position took a hit with the market decline on Thursday.
Remain vigilant. Be prepared to go to cash quickly if necessary. Stay calm and remain disciplined.
Does This Market level Make Sense?
- Written by Dr. Duke
The Standard and Poor’s 500 Index (SPX) gapped open Friday morning and continued to trade higher through the day, closing at 3194. The S&P 500 index is now only 6% below the pre-correction high. That doesn’t seem possible, but it is what it is. The 200-day moving average (dma) is now far behind us. It appears as though the pre-correction high at 3386 is now the next resistance level. Trading volume for the S&P 500 companies popped higher late this week, and spiked up to 4.7 billion shares today, well above the 50 dma at 3.3 billion shares.
VIX, the volatility index for the S&P 500 options, closed Friday at 24.5%. Although the VIX has steadily declined from the peak of the correction, the current level of volatility remains historically high. Traders should keep this volatility level in mind as we watch the markets just continue higher.
IWM, the ETF based on the Russell 2000 group of companies, gapped open higher Friday morning and closed at 150.20. IWM broke out well above its 200 dma at 146.57. IWM appears to be accelerating in its run higher, but remains 11% below its pre-correction high at 168.16.
The NASDAQ Composite index steadily traded higher this week and closed Friday at 9814. NASDAQ has now recovered its pre-correction high (to be precise, today’s close was 0.03% below the previous high). This should be good news, but it worries me.
Market analysts are trying to determine where the markets should be priced in light of the economic damage created by the overreaction to the coronavirus. The markets corrected between 32% and 43%. As of today’s close, the NASDAQ Composite has now recovered all of its correction losses. The S&P 500 companies are only off 6% from the pre-correction highs. How is this possible? Have we become too optimistic about this recovery? The strength of today’s market blew my mind. All three of the indices above gapped open strongly and never looked back.
What do we know about the economic damage? I have seen estimates ranging from thirty to forty million Americans unemployed. The numbers being bandied about for small businesses that will never reopen are frightening. Even the current huge unemployment estimates may be low. How can the current market levels make economic sense? Many analysts were saying the market was overbought before this correction. Now what do they think?
However, one of the most fundamental of trading rules is to trade what you see and not what “you think should be happening”. I am continuing to make good money in this market. But don’t forget the market summary above. If market analysts start to reassess their estimates of the economic damage, this market could take a tumble. Remain vigilant. Be prepared to go to cash quickly if necessary. Stay calm and remain disciplined.
Prospects of Reopening Boosts Stocks
- Written by Dr. Duke
The market put on a strong finish to this week, with the Standard and Poor’s 500 Index (SPX) closing at 2489, for a gain of 3.3% for the week. However, a large portion of that gain occurred on Friday. SPX gapped open higher in the morning and broke out above the 50 day moving average (dma). Trading volume for the S&P 500 companies ran below the 50 dma all week and just touched the average level today. The enthusiasm appeared to be generated by a combination of positive news from GILD on remdesivir, Boeing’s announcement of resumed production on April 20th, and President Trump’s announcement of guidelines for reopening the economy.
VIX, the volatility index for the S&P 500 options, opened the week at 44.6% and steadily declined all week to close today at 38.2%. Declining volatility is welcome news, but this level of volatility is normally near the peak of severe corrections, so remain vigilant. The large institutional players remain on edge.
IWM, the ETF based on the Russell 2000 group of companies, gapped open higher Friday and closed at 122.06. In spite of the strength in IWM, it ended the week very close to unchanged. IWM remains well below its 50 dma. The Russell stocks are small to mid-cap stocks that may be more susceptible to significant economic damage resulting from the economic shutdown. That may be the reason IWM is trading less strongly than the S&P 500 companies or the NASDAQ Composite. Normally, these stocks would be leading a strong bullish move like we have seen over the past two weeks.
The NASDAQ Composite index closed Friday at 8650, up 118 or 1.4% on the day. NASDAQ gained 6.4% for the week. NASDAQ gapped open yesterday, pulled back during the day, but recovered to close near its open. This intraday recovery was a strong bullish signal. NASDAQ broke above its 50 dma on Tuesday and confirmed that breakout yesterday and today. Trading volume varied this week, exceeding the 50 dma twice and closing today just below average.
The high levels of volatility should give us pause. This market will continue to fluctuate widely based on daily news and rumors. It is fair to say that the depths of the correction were definitely oversold and those overreactions are normal for the market. The critical question is determining what stock prices will be justified once all of the damage to the economy has been clarified. We know it is bad, but how bad? It would not be reasonable to expect the market to recover to the pre-correction levels anytime soon, but it is unclear at this point what market levels are sustainable.
I do not subscribe to the extreme market bulls who believe reopening the economy will get us back on track in short order. However, the doomsday gurus are out in force with their dire predictions. Reality will be somewhere in between these extremes.
Stay calm and remain disciplined. Take small positions and place your stops aggressively. It is possible to make a lot of money in high volatility markets, but keep one perennial point in mind. High volatility correlates with high potential gains, but those gains are always accompanied by higher risk.
Is It Safe To Come Out?
- Written by Dr. Duke
The Standard and Poor’s 500 Index (SPX) closed Friday at 2541, and for a welcome change of pace, SPX was actually up almost 11% for the week. Trading volume for the S&P 500 companies fell off this week as the market started to recover but remained above the 50-day moving average (dma) all week.
VIX, the volatility index for the S&P 500 options, opened the week at 74% and closed the week at 66%, exactly where VIX closed last week. Tuesday posted a huge intraday low of 36%, but that couldn’t hold. The markets may be calming somewhat, but we are far from normal.
IWM, the ETF based on the Russell 2000 group of small to mid-cap stocks, closed Friday at 112.56 for a weekly gain of 10.9%. All of the broad market indices paused on Friday after a week of positive daily moves higher, but IWM didn’t give back much of the week’s gains. The relative strength of the Russell 200 stocks is encouraging.
The NASDAQ Composite index closed Friday at 7502 for a weekly gain of 9.6%. NASDAQ’s low on Wednesday set this index’s correction at 32%. Like the other broad market indices, NASDAQ posted gains all week but gave a little back on Friday. Trading volume declined slowly over the week but remained above the 50 dma all week.
The source of this severe market correction is not the usual economic cycle downturn or the crashing of a housing or dot com bubble. This correction is the result of the coronavirus pandemic. The latest CDC update of March 29th reports a total of 122,653 coronavirus infections and 2,112 deaths in the U.S. CDC changed its reporting for the current flu season this week and changed all results to ranges based on the uncertainty of their data gathering procedures. Current CDC estimates are 38 to 54 million flu infections and 24 to 62 thousand resulting deaths.
The media continue to handle this pandemic irresponsibly. Just listen to the press questions at any of the coronavirus press conferences. The press have an agenda and it isn’t connected to the well-being of the public. They are promoting panic. Even when CDC officials say it is safe to return to work, people will be too scared to leave their houses. Then the headlines will turn to the economic depression that the media created for their own purposes.
I described IBD’s (Investor’s Business Daily’s) Follow Through Day methodology in the March 13th newsletter. The day count of that methodology begins with a strong bullish day on above average trading volume. That day count began with the strong bullish day on the S&P chart this past Tuesday. The count continues as long as Tuesday’s low of 2344 isn’t broken. Friday makes Day Four. Now we watch for a strong bullish day on above average trading volume. That will be the Follow Through Day and gives us a higher probability of reentering the market successfully after the correction. If SPX breaks 2344, we restart the process.
In the meantime, be extremely picky with your trades. AMZN, WMT and DPZ are benefiting from this economic lock down and may be good choices for sticking your toes back in the water. Be cautious about entering any new positions. When you do decide to pull the trigger, trade small.
Stay calm and remain disciplined.
- Written by Dr. Duke
The Standard and Poor’s 500 Index (SPX) closed Friday at 2305, down 8.1% for the week. Wednesday’s intraday low at 2281 for a correction of 33% is the low thus far. It was encouraging to see the intraday lows on Thursday and Friday did not break that correction low. Of course, you may recall my hope that last Thursday’s low was the capitulation, but that wasn’t the case. Trading volume for the S&P 500 companies has remained well above the 50-day moving average (dma) since this correction began and set a new high on Friday with 5.3 billion shares. That record high volume together with a low closing index value suggests capitulation. But the media are working overtime to keep the hysteria going.
VIX, the volatility index for the S&P 500 options, opened the week at 58 and closed the week at 66%. But that ignores some extreme volatility during the week, with intraday highs of 85.5% on Wednesday and 84.3% on Thursday. Friday’s range in VIX was huge with a high at 70%, a low at 57% and a close at 66%. VIX remains at very high levels, but it seems that the extremes of 80% plus may be behind us. VIX hit its record high of 89.5% on October 24th, 2008.
IWM, the ETF based on the Russell 2000 group of small to mid-cap stocks, closed Friday at 101.40 for a weekly loss of 6.6%. The intraday low on Thursday at 95.69 represented a 43% correction from the recent high on February 20th. All of the broad market indices posted gains on Thursday, but IWM gave back the least on Friday. The relative strength of the Russell 200 stocks is encouraging.
The NASDAQ Composite index closed Friday at 6880 for a weekly loss of 6.9%. NASDAQ’s low on Wednesday set this index’s correction at 32%. Like the other broad market indices, NASDAQ posted gains this past Thursday but gave it all back on Friday. The only good news is that the lows set Wednesday weren’t broken. Trading volume was above average all week and popped up to 4.8 billion shares on Friday.
The source of this severe market correction is not the usual economic cycle downturn or the crashing of a housing or dot com bubble. This correction is the result of the coronavirus pandemic. The latest CDC update of March 20th reports a total of 15,219 coronavirus infections and 201 deaths in the U.S. At the same time, CDC reports over twenty-three thousand people have died during this flu season and this year is tracking to be much less lethal than last year’s flu season, which claimed 80,000 lives.
The media have created and fueled the coronavirus panic. Many are using this crisis to further their political ambitions and the media are happy anytime they have the opportunity to create sensational headlines. The true tragedy is not the number of people who are and will be afflicted with this latest viral epidemic. It is the far greater number of people who are losing their jobs and income, plus losing significant portions of their retirement assets in 401k and IRA accounts. The so-called journalists who are irresponsibly creating the panic are among the wealthiest of Americans. This crisis won’t affect them.
The damage is done. Let’s concentrate on optimizing our market posture. It is too early to proclaim any good news, but we can take some comfort in the fact that the lows posted for all of the broad market indices remained unbroken on Friday. The correction high for VIX, the S&P 500 volatility index, was 85.5% and VIX closed Friday at 66.0%. The peaking of volatility is a tentatively positive sign, even though a VIX reading of 66% is certainly not encouraging.
In the meantime, be extremely picky with your trades. When I saw VIX getting very close to the 2008 high, I sold the VIX Apr 85/90 call spread. This is certainly a speculative trade, so I entered it in relatively small volume. Begin to build a watch list of solid stocks that have handled this correction reasonably well. For example, focus on stocks where the 50 dma remains above the 200 dma, and the stock price is above the 200 dma. The following stocks not only met those criteria, but the current stock price remains above the 50 dma: CHWY, CLX, CTXS, GSX, NET, REGN, and ZM. Be cautious about entering positions with these stocks now; see what next week brings. When you do decide to pull the trigger, trade small.
Stay calm and be disciplined.
Are We Overreacting?
- Written by Dr. Duke
I entered the VIX trade this morning for our trading group based on two recent data points.
One was seeing VIX hit a high yesterday very close to the high reached during the 2008 financial crisis.
Two was an article I read this morning. Here is the link.
Dr. Ioannidis, an epidemiologist from Stanford points out the critical errors being made in the analysis of the infection date for coronavirus and the extreme responses from WHO, CDC and the media coverage. The main points:
The current mortality rate for ordinary flu so far this season is 0.6%.
The widely publicized mortality rates for coronavirus are exaggerated simply because of how few people have been tested and the fact that the ones being tested are largely the elderly who are most susceptible and therefore seeking medical assistance.
He maintains that the Diamond Princess cruise ship is the best set of data to date, in effect, a limited "test tube", resulting in seven deaths from 700 infected crew and passengers, or a 1% mortality rate. But the demographics of the passengers are predominantly the older members of our population who are most susceptible to not only this virus but also the ordinary flu virus. When he adjusted that data to match the demographics of the U.S. population, the mortality rate is estimated to be in the range of 0.03% to 0.6%. Adding uncertainties such as passengers dying later from their infections or the possibility that the number of underlying chronic health issues may have been higher in this data set, he adjusted his estimate of the mortality rate for the general population in the U.S. to 0.05% to 1%. Contrast that with the WHO mortality rate of 3.4%.
When you count the financial costs we are incurring, the cure is worse than the disease.
The First Media Induced Recession
- Written by Dr. Duke
The Standard and Poor’s 500 Index (SPX) closed Friday at 2711, down 5.3% for the week. But what a difference a day can make. SPX closed Thursday at 2481, down 13.4%. Wow! Friday afternoon’s price action was wild. Any traders who left their offices a half hour early had a surprise waiting for them when they arrived home. At 3:34 pm ET, SPX was trading at 2548, down almost one percent since the open. In those remaining 26 minutes the S&P 500 ran up 163 points or 6.4% to close at 2711, resulting in a 5.5% gain for the day. Thursday's low represented a correction of 27%.
We observed a much weaker bullish spurt last Friday afternoon, March 6th, and I was encouraged. Those hopes were dashed on Monday as the market gapped open lower and sunk to a new correction low of 19%. Was this past Thursday’s low finally the capitulation we have been waiting for? Or will this just turn out to be another head fake?
VIX, the volatility index for the S&P 500 options, opened the week at 41.9%, peaked Thursday at 76.8%, and closed the week at 57.8%. I am impressed with Friday’s market strength, but the market is still very spooked. This remains a dangerous market environment.
IWM, the ETF based on the Russell 2000 group of small to mid-cap stocks, closed Friday at 119.47 for a weekly loss of 10.9%. The intraday low on Friday at 109.55 represented a 35% correction from the recent high on February 20th. IWM’s bounce on Friday was very impressive. After opening the day at 118.31, IWM plunged to 109.55, and then recovered to close at 119.47, posting a gain of 7.50 points or about 1% for the day.
The NASDAQ Composite index closed Friday at 7875 for a gain of 673 or 9.4%. NASDAQ’s low on Thursday set this index’s correction at 27%. NASDAQ tested Thursday’s lows on Friday but then spiked higher in a strong recovery, opening at 7610, falling to 7219, and then spiking to close at 7875. Trading volume was above average all week but unexpectedly dropped off during the recovery Friday
The source of this severe market correction is not the usual economic cycle downturn or a crashing housing bubble that we saw in 2008. This correction is the result of the coronavirus pandemic. The latest CDC update of March 13th cites a total of 1,629 coronavirus infections and 41 deaths in the U.S. By contrast, the CDC reports over eighteen thousand people have died during this flu season and this year is tracking to be much less lethal than last year’s flu season, which claimed 80,000 lives.
Contrast this current reaction of CDC and the media to the coronavirus epidemic to the H1N1 viral epidemic in 2009. The actions taken by the CDC are very similar, if not identical. That should not be surprising. CDC leads the world in epidemiology and their play book is well established. But the media’s response could not be more different. We were certainly alerted to the problem and advised of proper precautions in 2009. But the media did not create a panic as they have today, resulting in people fighting over toilet paper, sports seasons cancelling their seasons, and even churches closing their doors. In 2009, 61 million H1N1 infections were reported to the CDC, resulting in 12,469 deaths.
By contrast, the fear of this coronavirus epidemic has been greatly overblown as compared to H1N1 in 2009. What is the difference? Allow me to address the elephant in the room. The difference is the occupant of the Oval Office. The media fawned over President Obama. They helped his administration assure the public that appropriate steps were being taken. The majority of the current media hate President Trump and take every opportunity to critique every action taken and promote fear of widespread death and the basic collapse of our society. You think that statement is too strong? How do we explain the run on bottled water and toilet paper? Whether I like President Trump or not is irrelevant to this analysis.
This irresponsible scare mongering has resulted in tangible economic consequences. When Disney closes their U.S. theme parks tomorrow, how many workers will be affected? And that list goes on and on through many industries. My wife and I went to one of our favorite breakfast restaurants this morning. We were the only customers in the dining room. How long before those employees lose their jobs? This will be the first media induced economic recession in history. The citizens of our country who are least able to weather the storm will suffer the most. The talking heads who sound the latest breathless alarms are collecting multi-million dollar salaries.
We can’t control the cause of the market correction or even reverse it at this point. But we can use our normal technical analysis together with some basic common sense to determine our market posture. Recurring price patterns commonly follow market corrections. The most obvious is the retest of the correction lows after we think all is well and the market is recovering. If we had been encouraged by the market’s recovery on the previous Friday (3/6), and entered strong bullish positions, we would have been scrambling on Monday.
Notice the size of the corrections. SPX and NASDAQ are identical at 27% and IWM (our surrogate for the Russell 2000 index) corrected 35%. IWM consists of higher beta stocks. These are the classic “risk on” and “risk off” stocks. When traders are confident in the underlying bull market, they buy these stocks to lock in higher percentage gains. Conversely, these are the first stocks sold when any fear arises, so a larger correction is expected.
The recovery on Friday afternoon tracks the percentage gain from the intraday lows for each index to its close; SPX and NASDAQ recovered 8.8% and IWM recovered 9.1%. The consistency here is encouraging. A possible negative sign would be a smaller recovery in the small to mid-caps stocks typical of IWM and the Russell 2000 index. A consistent recovery suggests a larger market consensus of the correction being at or near its bottom.
Don’t make any bullish moves yet. Let the market's price action recover sufficiently to give you confidence that the retests of the correction are over. In the meantime, build a watch list of solid stocks that recovered well on Friday. This isn’t a time for your favorite biotech with the cure for cancer in clinical trials. Some of the stocks on my list are: APPL, ADBE, COST, INTC, LLY, MSFT, PYPL, REGN, and UNH. All of these stocks made strong recoveries on Friday and some even regained their 50 dma.
Stay calm and be disciplined.