Mike Santoli's market notes: What's behind the rout and how long could it last?

Published Thu, Jun 11 20201:44 PM EDT

We were set up for some payback, and are getting a bit of it. After two days of heavy selling in most stocks that was obscured by resilience of the big-cap indexes, the overall tape succumbed to stretched technical conditions, overheated trader sentiment and a few prominent excuses to question the pace and path of economic improvement. "Routine" pullbacks and more serious declines look and feel similar at the start. No real reason yet to assume this will deepen beyond the routine range. But another, say, 5-8% down from here would fit into the "no big deal" category from a wide angle after a 45% ramp off the March lows. Might not feel like no big deal along the way if it happens, but this is how it works. At the open today we'd essentially undone the Friday jobs-surprise pop and round-tripped to last Thursday's levels. This leaves the recent highs stranded on a so-called "island" separate by watery gaps on the chart. Nothing insurmountable but combined with yesterday's "firsts" such as Nasdaq's initial close above 10,000 and Tesla 's first close above $1,000, not hard to get folks thinking it was a culmination. Here are some thresholds to note in the event this shakeout deepens from here: We've had two 5% pullbacks during the March-June rally, nothing deeper. A 5% dip from the closing high of 3232 in the S & P is 3070 – there now. The 200-day moving average is 3013, down another 2% from the current quote, and is about flat, and gave no resistance on the way up, so who knows the significance now. The 50-day average is 2895. In bull markets it pays to buy breaks of the 50-day, so maybe if it's touched it gets a bid. At what level would the S & P's dividend yield be back up to 2%, a level that has been a decent proxy for stabilization for years now? About 2980. And if the S & P sank all the way to 2800 – a level first reached on the rebound two months ago – then the forward P/E of the index would be back down to 20x. Certainly Jerome Powell's resolute focus on the downside risks can be raised as a handy excuse for investors to reassess what's baked into stocks. But we're beyond the days when the Fed seems to have any privileged view of the outlook. He just offered a reminder of how far we are from the path directly back to normal. Powell's comments on asset buying to "keep markets functioning" was muddled and defensive, but him saying he won't "take the [liquidity] gains for granted] points out some underlying fragility in the capital markets (credit spreads still elevated, volatility stubbornly juiced, thin and jumpy futures markets). Yes, we're also forced to focus on the surging infection/hospitalization rates in big "open" states. I've noted we were in a "free pass" period when the bear case on reopening could not be proven for weeks. That hasn't truly expired but we're deep into it. Speaks to just how much consumer enthusiasm we'll have even after reopening, though. Calendar also inching closer to a perceived "fiscal cliff" when things such as enhanced unemployment benefits expire around July 31, and so far no strong push for another fiscal package at the moment. Decent chance this is simply a sharp reset, painful for the recently converted bulls, to drain away some of the excessive optimism and extreme overbought conditions. The longer-term implications (3/6/12 months) for the kind of powerfully broad and persistent rally we saw off the March bottom are for above-average returns, though often with a choppy corrective period in the shorter term. Yes, ours are extraordinary circumstances but the history is the history. Credit spreads backing up as Treasury yields compress post-Fed. Breadth is phenomenally negative – 97% downside volume on the NYSE. Quite a nasty purge, and the equal-weighted Russell 1000 is already down 10% from Monday's high – a nice flush, maybe has already gone a good distance toward skimming the froth from the market. Only the stocks of the necessities are higher: Kroger, Clorox , Walmart ….and Netflix. The VIX never fully endorsed the last up leg of the rally and now has been triggered higher, above 33 and potentially in another uptrend just as seasonal factors turn dicey. If this is a one-day air pocket, look for it to retreat at least three points from its high in a day as a short-term sign of market stabilization.

We were set up for some payback, and are getting a bit of it. After two days of heavy selling in most stocks that was obscured by resilience of the big-cap indexes, the overall tape succumbed to stretched technical conditions, overheated trader sentiment and a few prominent excuses to question the pace and path of economic improvement.