• From a technical standpoint, some considerable damage has occurred, particularly in the large cap, S&P 500 Index or by its most popular exchange-traded product , SPY
• Global market risks are beginning to be priced in after ten years
• Corporate tax cuts were a catalyst behind the latest run-up of U.S Equities, but other headwinds in the market are at play.
• Q3 Earnings have been good, but the outlook by major companies is softening

By, Bill Herrmann, Founder and CEO of Wilshire Phoenix

U.S Equity Markets were slammed last week in a sell-off that began on October 10th. The S&P 500, the most popular market gauge, fell more than 4% on the week, which is proving to be the worst October in a decade.

Where is this sell-off suddenly coming from?

Only a few weeks ago, news outlets still used popular narratives around strong fundamentals and a booming economy.

Admittedly, corporate tax cuts and the prospect of the repatriation of funds to U.S based global companies from overseas could be argued catalysts. But, those potential catalysts have been trumped by other headwinds in the market.

What else could be at play? Here are a few possibilities…

- Trade wars and a slowdown in China
- Interest Rates on the Rise
- U.S Treasuries and Corporate Bonds Fall (see prior)
- End of Quantitative Easing
- Mathematics, Logic, or Rational Thinking
- Rising Labor and Borrowing Costs for U.S Companies
- Brexit (this is still not priced in)
- Q3 Corporate Earnings have been good, but the outlook for Q4 and beyond is not
- Rising Dollar beginning to hit U.S Exports
- Currency/Country Issues, such as Argentina and Turkey
- Stretched Corporate Valuations
- Overbought Conditions across Global Markets
- Traders Beginning to Price in a Slowdown/Potential Recession
- Over 24 Trillion in Debt (United States, only)
- Hawkish Fed
- Uncertainty around the Mid-Term Elections

We will never know if one, some, most, all or none of these items precipitated the global market sell-off this month.

It may just be, that, prolonged periods of stability lead to significant instability.

On October 9th, one day before the global sell-off commenced, we noted the following in our piece on Intermarket Analysis.

“…institutions are not participating in a meaningful manner; investors are chasing – that’s not sustainable. The so-called “smart money” is selling into strength, but that strength, for lack of the better word is synthetic. To be clear, this is not my opinion and is evident by low overall volume on up days and high volume on down days…There is much noise in the equity markets, and in all markets for that matter, but it is as clear of a signal that any retail investor will ever receive; this is powerful information…”

Since then, markets have been decimated. From a technical standpoint, some considerable damage has occurred, particularly in the S&P 500. With, among other things, the popular moving averages that typically serve as support, all taken out. Most notable, however, is the break of the upward trend that has been in place, all the way back to 2016, which is outlined in the below chart.

Chart courtesy of StockCharts.com

The S&P 500 finished last week less than 2 points from ending in correction. However, the popular benchmark has significant support ahead at 2600, which is only about 60 points away. However, this zone of support is important and will need to hold (noted in the chart, above). Any break below 2550 will bring substantial declines and to an almost certain bear market (which is a 20% decline).

The market rout has not been isolated, with the tech-heavy Nasdaq now in correction territory (which is a 10% decline) together with mid-caps and the transports. As to individual sectors: industrials, energy, materials, and consumer discretionary stocks, join the Nasdaq in correction. Banks and semiconductor have also been miserable as they recently breached their 2018 lows.

The Financial Times had this to say in an Editorial posted on Sunday.

“Globally, it now seems clear; a broad adjustment is underway… The backdrop remains the end of the easy money, in the form of the quantitative easing, that has floated all boats for the decade since the financial crisis. The Federal Reserve is in full withdrawal mode, reducing its balance sheet by $50bn a month… But ending QE means a return to more normal levels of market volatility…And in the US and beyond, fundamentals look less robust than a few months ago….rising labor, input and borrowing costs mean corporate margins may have peaked, crimping the outlook for earnings growth. While President Donald Trump’s tax cuts have pumped up domestic demand, forecasters say their impact may dissipate beyond mid-2019 or even earlier. The midterm elections leave the economic policy outlook in question. US exporters, meanwhile, are being squeezed by a strengthening dollar, and potentially weakening demand overseas…”

Financial Times Editorial, “For Investors, risks are becoming hard to ignore” 10/28/18

However, it is not all grave news.

Unlike the S&P 500 (and most of the other majors), the Dow Jones Industrial Average still has not broken below its key uptrend line. If the Dow closes below this uptrend line on high- volume, the next important support level to watch is the 23,250 to 23,500 zone that formed at the beginning of 2018 (noted in below chart). The Dow ended Friday’s session down 296 Points to 24,688.31.

Chart courtesy of StockCharts.com

It is important to know that this is not a repeat of 2008/09. We are witnessing the market and business cycle naturally progressing through each stage.

However, it does look like a recession in the near-term is a highly probable scenario based off of the most recent economic data. If the data continues to deteriorate at this pace a dramatic slow-down in the overall economy will have commenced by 2Q19.

Provided, however, I left my crystal ball at home.

ABOUT THE AUTHOR

Bill Herrmann is the Founder and CEO of Wilshire Phoenix. Prior to its founding in 2017, Bill was employed by BNY Mellon from 2005 to 2016, most recently as a Vice President of Dealing and Trading. The capital markets have been a passion of Bill’s from an early age. Starting in 1999, and just a sophomore in high school, he worked on the floor of New York Stock Exchange (NYSE) for market specialist firm Scavone, Mckenna, Cloud & Co. He has been trading the global equity, derivative, credit, and fixed-income markets since 2003, while still attending university. Bill completed undergraduate studies at Clarion University of Pennsylvania and graduate studies at New York University.