The Fed cut rates this weekend, but the market is still dropping. How bad can it get?

Instead of following my normal routine, which is to highlight a specific stock, I think today it’s probably a good idea to pull the lens back and take a look at the broader market. It’s practically impossible to ignore the fact that the market dropped into bear market territory last week. Fear and, yes, even panic driven by the spread of coronavirus (now generally just referred to as COVID-19), the government’s reaction (or, as some would argue, inaction) to the outbreak, along with organizations on just about every level of society from government to public schools to businesses taking drastic measures to limit the potential for exposure has many worried not only about the short-term impact but that the sickness will plunge us directly into a fresh new recession.

The Fed took some of the most drastic measures yet over the weekend, slashing overnight lending rates to zero and injecting a massive amount of liquidity into the bond market of $700 billion in new bond purchases. Instead of propping up the market this morning, as some may have hoped, investors used the news as justification to start a fresh new wave of selling. As of this writing, the S&P 500 dropped to a low point around 2,400 before rebounding a bit, but is still about -6% lower on the day.

I suppose that if you think about the psychology of fear that often drives the markets, these conditions aren’t too surprising. Over the years, I’ve heard a lot of analysts use terms like “buy the rumor, sell the news” to try to describe how the market tries to anticipate economic and fundamental indications of weakness or strength. That means that investors often tend to “price in” their emotions through the stock market; if they expect the economy to be strong, even if current indicators may not indicate such, they’ll start buying. In the same way, if investors simply expect rough going, it doesn’t really matter what indications of broad economic strength or health there may be; they’ll usually just sell anyway.

Even this morning, as analysts have continued to hold their breath while watching the indices plunge lower yet again, it was interesting to me to see them point out that while the spread of COVID-19 is going to cause an economic impact, investors are, as expected, overshooting the mark. Market reactions tend to be overly severe, or overly enthusiastic. Last year’s bull rally is a good example of how investors pushed stocks higher across the board, to extreme, even unjustifiable levels. I think we’re seeing the same thing happen right now, to the opposite extreme. 

Businesses are shutting down, religious organizations are cancelling worship services, sports leagues are cancelling tournaments, suspending seasons, schools have put students in a temporary holding pattern, telling them to stay at home. All of this is bound to be felt in an economic sense, and I do believe when there are measurable numbers related to everything from manufacturing product to consumer prices and confidence in the weeks and couple of months ahead, we are going to see a decline in activity. At this stage, though, the market is down nearly -30%. Is the economy also going to decline by -30%? I don’t think so.

Let’s take a technical look at the markets and see where they sit right now.

This is a five year chart of the S&P 500 Index. Each candlestick represents one week of time, as opposed to the one-day periods I usually use. This is useful to put the market’s current drop up against the longer upward trend that lasted until February. The dotted red line marks the last support, where the market sat at the end of last week based on pivot lows from early 2018. Our next support is the first horizontal green line, which is sitting at just around 2,350. The index came close to that level earlier today, but now appears to have pushed higher, using that level as a support point. Will it hold the rest of the day, or possibly even give the market a point to use for additional stabilization in the days ahead? We’ll just have to wait and see; but I think the 2,350 level is the next level you should pay attention to.

The lower, horizontal green line that sits a little above 2,100 is the next most likely support point, based on a lot of consolidation levels shown at that point based on pivot highs and lows seen at several points in 2015 and late 2016. If we drop below 2,350, look for strong support around 2,100. That’s a decline of about 37% from the index’ February high, which is a big deal, but given where the market sits right now, doesn’t really mark a ton of remaining downside. Any kind of indications of consolidation between 2,350 and 2,100 could offer signs that the worst be over – at least for the stock market. The silver lining is that the market drop into bear market territory has put a lot of really interesting stocks down to very compelling bargain prices. That means that when the consolidation comes, there are going to be a lot of great buying opportunities, in a lot of different sectors and industries.


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