SPX braces for a gap down

Is Coronavirus a Black Swan?

If there is such a thing as a self-fulfilling prophecy, the Coronavirus may be on its way to becoming the next ‘black swan’ of this market.

We’ve been asking ourselves the question for some time: what is going to bring this bull market down? After all, since last October, valuations just kept climbing.

Initially the markets shrugged off the idea that Coronavirus was that big of a deal… then some companies started specifically crediting the outbreak with an impact on financial numbers.

No big deal, the impact is baked into the price already.

But perhaps expectations of this outbreak missed the mark. Perhaps this as a lot more serious. A Biblical pandemic even?

Before borrowing a bunch of trouble, let’s look at things in context. The coronavirus is awful… but so is influenza. This is not ebola. While it is potentially lethal, the majority of those infected still survive the illness. This is not to trivialize coronavirus but to give us some perspective.

Currently, coronavirus is part of an active news cycle. It’s unknown, it’s scary, and it’s the perfect train wreck to get folks staring at their screen. In short, it’s an advertiser’s dream.

Since the stock markets have largely dismissed the circus that is Washington DC lately (thought if Bernie Sanders continues to gain momentum this could change) , the coronavirus news cycle keeps viewers glued to the screen. And the unknown factors that seep into the stock market are drawing this out more than the typical 1-week narrative.

So what are we to make of this?

First, a quick breakdown:

Fundamental data, as measured by BigFoot’s economic and credit macros, remains solid. Technical data, as measured by BigFoot’s market macro, is always solidly above any sell threshold.

All three major indexes (DJIA, SPX, NASDAQ) have ‘wait’ indicators… this is neither a sell nor a buy. It is simply an acknowledgment that downside volatility has increased (so buy at your own risk).

When looking at the technical price movement of the SPX, this week is setting up for a big gap down at the open. Futures are indicating somewhere close to 90 points of downside. That’s over 2.5%.

This is definitely a knock on the market’s momentum. But the truth is, the SPX upward pricing channel will not be broken unless the index closes below 2514 this week.

A close below this support level potentially throws everything out of whack. It would mean a close both below the 50-day moving average, and the prior support/capitulation point where buyers showed up to support the markets.

It also means there is very little pricing support all the way down to 3036 or so… so basically a drop back to the 3000 level for the SPX.

For the non-math-whiz reading this, that’s a full-blown correction.

But keep in mind, this market is gapping lower after a big up-trend. And it’s doing so on speculation and fear.

Perhaps the markets are getting it right. Maybe this is a pandemic-level event and global economies are going to completely grind to a halt. Or perhaps this is a classic over-reaction to fear.

The reality is, this market has been moving higher and higher with virtually no resistance since last October. It has spend most of its time at the top of its pricing range. This projected drop simply flips from the top of the 1-month trading range (1.5 standard deviations above the 1-month pricing average) to the bottom of the range (1.5 SD the below).

The jarring and scary nature of a pull-back like this can be enough to shake anyone’s confidence in this market. But keep in mind a handful of other odd details:

Oil is dropping but gold is climbing in price.

The US dollar is climbing, treasury prices have been dropping… and gold is climbing.

The gold thing is likely fear, where the rest of the data says this underpinnings of this market are fundamentally unchanged.

If anything, the spread of Coronavirus may further strengthen the US dollar, as other global economies are weaker that the US already. This could lead to further weakness, exacerbating the dollar’s strength… not great for trade, but great for keeping treasury yields low.

Bottom line: one day does not a trend make.

Monday is likely to be painful. The real interesting thing will be not how we open but how we close. If markets manage to open to big losses but pair more than 50% of those losses by close, that’s probably a pretty good sign that equities are still an attractive asset.

Don’t let the man behind the curtain (the media) fool you. Stick to the data and a process. This bull will eventually die. But let’s let the numbers do the killing rather than the rumors.

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