Friday, October 12, 2018

Sell Off: factors behind the correction

As all market sell off as the present, the analysts begin to look for explanations to it. Which main force is behind it, and if this trend will continue. Yesterday SPX dropped 3.3% and today 2.06%, causing it to break the important SMA200 level that for months had become invincible and caused successive rebounds when it price reached it. The Nasdaq COMP had its worst session in 2 years, dropping 4.1%. And VIX volatility skyrocketed to levels of $ 25, which did not have in months. There are some factors that have accumulated over time, and that have led to this expected correction. I throw some ideas about it.


SPX today below the three main moving averages and the Ichimoku cloud. This time it did not bounce on the SMA200, as he was doing for months, a clearly bearish signal.




Trump and the dollar: short and long term

It is not new the complicated relationship that Trump usually has with the FED, simply in these days it is reaching its highest peaks. His phrases generally scare Wall Street and this time they did more than ever. His statement 'the FED is going crazy' try to influence them, because he believes that the interest rate is going up very fast. With inflation already at 2% Trump may be right to want less Rate Hikes, despite the fact that the FED ensures that there are three years of growth for the US economy. 

On the other hand "I want to pay the debt" says always Trump. He is also right. It is impressive that with the two Obama governments the Federal Debt size near doubled, reaching its current total of $ 21 trillion. Although in the short term the debt allows economic growth, in the long term, while it grows with interest, it can become unmanageable. The Debt/GDP ratio grows and debt holders can request payments at larger interest rates. By decreasing the attractiveness of Treasury Bonds, it would further increase its interest rate, slowing down the economy.

For me it is clear that Trump needs a low dollar in the short term to stimulate strong exports to China and thus appease the effect of tariffs. And in the long term to alleviate the debt and not become unpayable in the future.

It is impressive that with the two Obama governments the Federal Debt size near doubled.


TNX Benchmark above 3%

The yield of the 10-year Treasury Bond TNX, has far surpassed the important resistance of 3%, confirming the break of the downward channel of many years and approaching the psychological 3.25% level. This could seem the main cause of this sell off, since it is known that the market is sensitive to these increases. However, TNX has been correcting for two days (today it closed at 3.13%, help by low CPI inflation data) and despite this, the market succumbed again today. There does not seem to be justification for the sell off, on the contrary, it may be that the bonds are already acting as a refuge, in addition to gold. Incredibly, one of the causes of panic on Wall Street, the rise of TNX, became a safe haven in just a couple of sessions, because today the bonds went up. My forecast is that, after this sell off, this yield will continue its rise to 3.5% in order to give steep to the yield curve that is flattening in excess, not consistent with a strong growth economy where no recession is seen in sight.

TNX in bull field since the break of the downtrend channel a year ago, confirmed with the MACD reinforcement. After this sell off, its path to higher yields is free.



Stock Buyback "Blackout"

Another apparent cause for the current sell off is the "blackout" of stock buybacks, that is, the impediment to companies from repurchasing their shares two weeks before the end of the quarter. However this is not official: some companies have it planned and they do it legally. With companies as the largest buyers of stocks, it is very difficult for the SPX to go down so that millions of sales will occur. The corporate buyback reinforces the price and reduces the number of shares available, making it more prone to increases.


While I consider the stock buyback the main reason why the US Stock Market rises while the rest of the world fall, I do not think it is a reason for the present sell off, because this did not happen in the previous blackouts of this year. Maybe if, the repurchases have reached their top, with a record of $ 680B only in the first half of the year, projected to  $842B until the end of the year. Artificial growth that at some point will end.


Companies record repurchases of its own share is the main factor 
that keep the US Stock market in all time highs.


Technical correction

We are in the expected technical correction? I think it's the most likely. The technological sector XLK has been requiring it for a while. Its completely overbought and it seems to be a profit taking what is happening. And this carry the rest of indices and sectors. Tomorrow friday, all traders eyes are in the SPX chart recent break at the SMA200 average support. If it does not bounce firmly in the next days, you can expect a greater fall, of unpredictable end. If bounces, probably we would have the usually Christmas mini-rally next months.

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