The Standard and Poor’s 500 Index (SPX) has been trapped in a sideways trading channel for the past couple of months. SPX dramatically broke out of that channel on Friday, closing at $2128, down $53 or 2.4%. SPX gapped lower Friday morning, opening at $2169, and didn’t even pause as it broke the 50 day moving average (dma) and then took out long-term support at $2160. Even more ominously, all three major broad based indices, SPX, RUT and the NASDAQ Composite, closed at their intraday lows. This type of close is very bearish; go back and study the charts preceding the August flash crash from last year.
What triggered this breakout? The best answer appears to be recent interviews with two FOMC members suggesting a rate hike may come as soon as the Fed meeting later this month. This certainly isn’t the first time that the market has seemed to freak out over a quarter point interest rate move. To my mind, it doesn’t make any more sense this time than it has previously. Interest rates are going to remain below one percent for the balance of 2016 in all plausible scenarios. Would that increase in interest rates throw cold water on business expansion plans? I seriously doubt it. For that reason, I think this correction will be brief, but that doesn’t mean we should just sit on our hands.
On the other hand, perhaps weak economic data, such as one percent GDP growth, and a string of five consecutive quarters of declining corporate earnings, are beginning to weigh on the market. The Russell 2000 Index (RUT) closed Friday at $1219, down $39 or 3.1%. RUT has been trading higher since the BREXIT panic, so Friday’s large move wasn’t a breakout from a sideways channel as it was with SPX. RUT closed on Friday near a solid support level around $1220. RUT remains as the only major market index that has failed to make new all-time highs over the past couple of months. The lagging behavior of RUT as other indices traded higher suggested some restraint on the part of the bulls. But RUT’s smaller drop on Friday also suggests that the bearish action has not fully impacted the small caps as yet. If we see a solid break of the 50 dma on Monday, that would underscore the bearish move.
Volatility spiked much higher on Friday, with the VIX closing at 17.5%, up five points in one day. Those of you speculating with VIX calls are celebrating this weekend.
Given the backdrop of weak GDP growth and declining corporate earnings, a bearish move certainly shouldn’t be surprising. The surprise is the suddenness of the move and the move being attributed to the possibility of the Fed increasing interest rates at the meeting this month. Perhaps this is just one more illustration of a nervous market that can turn on a dime in either direction, e.g., the BREXIT panic resulting in a large price decline for only two days, followed by a prolonged bullish run higher.
The Federal Reserve has historically maintained a strong non-political posture. I don’t think that is likely to change, so the prospect of the FOMC raising interest rates on September 21st, less than two months ahead of the presidential election, seems very unlikely. Thus, I would not expect Friday’s significant price drop to continue on Monday, which is why I held my positions on Friday, and even sold some far OTM SPX put spreads. But if this decline continues on Monday, I will be aggressively closing and/or hedging positions.
