Stocks plunge may have been a too fearful reaction to trade, economic worries

  • Stocks plunged on warnings from the bond market that the global economy could be slowing, but strategists say it may be overreacting.
  • A bond market move, where longer duration interest rates fall below shorter duration rates, raised concerns that a recession is coming.
  • But analysts say it is typically far into the future before a recession hits, and stocks do fairly well ahead of that.
Traders signal offers in the S&P options pit at the Cboe Global Markets exchange.
Scott Olson | Getty Images
Traders signal offers in the S&P options pit at the Cboe Global Markets exchange.

After sharp gains in the past week amid hopes for a trade deal, stocks fell back into correction mode Tuesday, plunging on worries the trade talks could fail and that global growth is slowing.

But some strategists said the selling, which took the Dow down as much as 800 points intraday, appeared to be overdone and could have also been made heavier by the fact that the stock market is closed for a full day Wednesday for President George H.W. Bush's funeral. The selloff was also exacerbated by a big move in the bond market, with the trading there flashing warning signs about the economy.

"I don't think this continues. I think this is people with their hair on fire," said Steve Massocca, managing director with Wedbush Securities. "You had this rally that was based on this presumption that we had a deal with China. Now it's clear, we don't' have a deal with China. We might have progress, but we don't have a deal with China."

The S&P 500 lost 3.3 percent, falling to the psychological 2,700 level, while the Dow Jones Industrial Average was off 3 percent at 25,027. The Nasdaq was down 3.8 percent, falling back into correction territory, and the small cap Russell 2000 lost 4.4 percent, its worst day in seven years.

Selling in the S&P accelerated around midday. when it broke its 200-day moving average at 2,762. Apple, which has been a beacon of market sentiment, was battered, losing 4.4 percent amid more concerns about iPhone sales. Tech was broadly lower, losing 3.9 percent, while the best performing sector, utilities, was barely positive. Regional banks were down 5.6 percent in the worst day since June, 2016, as interest rates sank.

Scott Redler, partner with T3Live.com, said there could have been some selling ahead of Wednesday when the market will be closed since traders won't have the ability to control their positions. "For me cash is a position. We'll have to go into Thursday and Friday and see if today had a lot of meaning or not," he said.

President Donald Trump met with China President Xi Jinping Saturday, and the U.S. said it left the meeting with a standstill on new tariffs and an agreement on agriculture with China. But, reports have surfaced that China has a different version of events without the commitment on farm goods.

The worries about trade have been eating at investors, who have already been concerned that earnings will slow down next year, and so will stock market gains.

So it didn't help that the bond market was sending its own scary signals about slowing growth. One of the biggest catalysts for the selling Tuesday was the behavior of the yield curve, which shows the relationship between short and longer-term government bond yields. Buyers jumped into the 10-year Treasury note, pushing its yield sharply lower and closer to the 2-year note yield.

Since some short term yields have risen above the 5-year Treasury already, traders speculated that the same could soon happen between the 2-year notes and 10-year notes. That is what the market calls inversion and has been a recession signal for decades. The difference between the 2-year and 10-year yields was at a narrow 11 basis points in afternoon trading.

Paul Hickey, co-founder of Bespoke studied the behavior of stocks and the yield curve, and said he found the stock market did a little better on average over the course of the next three, six and 12 months, when the spread between the 10-year and 3-month bill fell below 50 basis. He said there were eight occurrences since 1962 when the spread fell below 50, and only six of them preceded a recession.

But the narrower, or flatter, the curve gets, "the worse it is for the market," he said. "Even worse for the market is when it's below 50 and already inverted." That spread fell below 50 for the first time in 11 years, and it is the part of the curve the Fed sees as most representative of fed funds.

"When you get the worse performance is after it inverts and gets positive again, and that's when you really see the market weaken," Hickey said.

Vinay Pande, head of trading strategies at UBS Global Wealth Management's Chief Investment Office, said recessions often do follow inversions but there is no consistent pattern. "It's between 50 to 600 days to an equity market top, going back to the 1980s. This is not a very useful thing," he said.

Traders have been pointing to the speed at which the 10-year fell from above 3 percent to the 2.87 percent it was on Tuesday. Pande said part of the reason was that there was a large short position, and investors were forced to cover shorts, as well as some weak data points and inflation reports.

"We actually like the equity market here. I think the market has priced in a reasonably bad outcome," said Pande. Barring a failure of China and the U.S. to find a trade agreement, he said the market should be alright.
"Near term we think you should be buying the dips," he said.

Ari Wald, technical analyst at Oppenheimer, said Tuesday's selling was more of the same pullback that roiled the market in October and November, after its reprieve.

"The market is oscillating in that type of range bound manner. I think it's all suggestive of the same action we've really seen in recent months. This bottoming formation that's trying to take place. The S&P is still below key resistance at 2,815 sot he bottoming continues," he said.

Redler said the bottom of the range is 2,603 which the S&P hit in October. "The market is in a range. It's trying to figure out what the bigger picture looks like, while traders navigate the technical points. A contributing factor was that traders got caught in Apple" Monday when it traded higher. "It looked like it had relative strength, but then the Cirrus news came out and it got downgraded. It's another worm in the Apple."

Cirrus cut its guidance due to weakness in the smart phone market.