Is The Next Stock Market Crash Just Starting?

TL:DR

The S&P 500/SPX had run up by nearly 50% since its mid-March lows.

However, leadership became extremely thin in recent sessions as the “Big Five” and other large tech companies did much of the heavy lifting.

We also noticed massive underperformance in the Russell 2000/small-cap index yesterday, which alarmed us quite a bit.

I suspect this “pullback” to continue.

Target correction range is from 12%-20% from recent highs, or about 2,850-2,550 in SPX.

Is the next stock market crash just starting?

The S&P 500/SPX is down by around 188 points after closing today, breaking a key support level at 3,100, and repeatedly testing the critical level at 3,000.

This marks the 6^th worst trading day this year and the most severe drop since March as the Fed’s grim outlook and rising cases of coronavirus unsettle bulls.

Let’s unpack this.

First off, yesterday we covered some of the reasons why stocks were on the rise:

“What can we say is behind the current stock market rally? A few things stand out:

1) Bond yields are too low.

2) Low interest rates encourage leverage. It’s easy to find a margin rate of 1%.

3) The Fed just bought up trillions of dollars of bonds. So, whoever owned them before, had trillions of dollars in their accounts in cash. What are they going to do with that cash? The only investment option is equities.

There is also a bold and unequivocal consensus that a robust earnings recovery is on the way.”

Based on today, it looks like that the economic reality is not nearly as constructive as stock market optimism has been implying in recent weeks.

So, what’s the mainstream take on this bearish action?

1) Doubts raised about the pace and quality of the recovery from the current recession raised by Powell on Wednesday

On Wednesday the Fed’s updated policy statement and projections indicate that it expects a 6.5% contraction by the end of the year on a year-over-year basis, with the unemployment rate ending at 9.3%, well above the Fed’s estimate of the long-run rate forecast of 4.1%.

The central bank’s dour outlook has a lot to do with the stock market selloff, said Kristina Hooper, Invesco chief global market strategist.

“The stock market has almost had blinders on,” Hooper said in an interview. “More than one in three companies in the S&P 500 are dispensing with earnings guidance. So investors have anchored to data, which has been relatively positive about reopenings in various states, improvements in PMIs and the jobs report last week. In one fell swoop Jay Powell threw a lot of cold water on that narrative.”

Adding to this, the jobless claims numbers released today weren’t inspiring:

Initial Jobless Claims:

Survey: 1,550,000

Actual: 1,542,000

Prior Week: 1,877,000

Prior Week Revised: 1,897,000

Continuing Jobless Claims:

Survey: 20,000,000

Actual: 20,929,000

Prior Week: 21,487,000

Prior Week Revised: 21,268,000

Total Jobless claims in the last 11 weeks: 42,042,000

I think this is the key sentence:

The total number of people claiming benefits in all programs for the week ending May 23 was 29,505,027, a decrease of 662,143 from the previous week. There were 1,545,606 persons claiming benefits in all programs in the comparable week in 2019.

What we were hoping for was a pseudo V-shaped recovery (not that it was reasonable) which would mean that right around this time, we’d see a huge spike in employment because things are going back to normal in many places.

In contrast, it only went down 600k. We should be hoping for better.

2) Signs of rising cases of COVID-19 — a potential Second Wave Of Covid19

The global case tally for the coronavirus climbed to 7.39 million on Thursday, according to new data. The death toll rose to 417,022.

More than a dozen states are showing significant resurgences in Novel Coronavirus/CV cases. Naturally, this will likely weigh on consumer confidence, employment, other data, and overall economic growth.

However, is this really the second wave of the CV? 

Not likely, as this is probably just the extension of the first wave due to premature “re-openings,” relaxed attitudes, densely populated protests, and other factors. When the second wave comes it will likely be in the fall, coupled with the cold and flu season.

Please keep in mind that this could lead to a certain level of pandemonium, as many people will not be aware whether they have the flu, a cold, or the coronavirus. There will also likely be lots of uncertainty about the outcome of the election by then, another negative factor for markets overall.

Forward Outlook

We’ve been cautious throughout this rally, as it was artificially induced by enormous Fed stimulus, and we saw an evident disconnect between the real economy and the stock market. Furthermore, I never believed, and still do not believe, that the economy will return to “normal” any time soon.

In Q2 we started looking at adopting more gold, mining/GSM sector, and Bitcoin and other systemically important digital assets (e.g., DCR). The reasoning behind this was that these assets would outperform due to their inflation-proof/resistant qualities. After all, the Fed is printing an unprecedented amount of money, so it makes sense to own assets that should benefit from the underlying phenomenon.

Quite simply, fiat markets are no longer free markets, making hard assets and hard money more desirable. Mind you, market desire doesn’t have an equivalent correlation to market price, especially with new assets like Bitcoin. Even as BTC has outperformed every major index, the majority of capital and investors will still prefer to trade stocks that are better ingrained in the legacy financial system.

What’s Next?

We’ve seen a massive stock rally of nearly 50% from the mid-March lows. Many of the stocks we’ve traded over at ReadySetTrade have appreciated by 50%, 100%, 150% or even more in that timeframe. Now it’s time for a pullback, possibly even a correction.

The best-case scenario is that stocks bounce back from the current level. However, this is not likely in my view.

The selling may not stop there. The market could decline further to its next major area of support at around 2,850. This may be the likeliest scenario right now and would represent a correction of around 12%.

Nevertheless, in a more severe case scenario, the market could fall all the way back down to 2,550, roughly a 20% correction from recent highs.

Remember, this pullback/correction won’t happen in a vacuum.

As I’ve argued, The Fed and Jerome Powell are looking to make a power grab, and if their role as “savior” is seen as more justified as asset prices fall, then they’re increasingly “justified” for more drastic actions like directly buying major indexes or negative interest rates.

Such moves would cement the Fed as a power broker of market performance — the largest market whale in history.

The subsequent bump in asset prices is exactly what Trump and his party are looking for right now. Trump’s approval rating has slipped by 10% in the last month, so anything to help his reelection chances, namely economic recovery, is paramount.

The November election is only 5 months away.

Covid19 is not gone.

Unemployment is still rising.

Unrest is still rising.

The Fed is out of “conventional” monetary policy moves.

And 2020 is only halfway over.

Strap in.