David Moenning

About the Author David Moenning

David Moenning is a the Chief Investment Officer at Heritage Capital, which focuses on active risk management of the U.S. stock market. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Dave began his investment career in 1980 and has been an independent money manager since 1987. Thus, Dave has been live on the firing line and investing for a living for more than 25 years.

Why Has the Stock Market Suddenly Fallen Out of Bed?


The question of the day is why the stock market has suddenly fallen out of bed. Three days ago, the S&P 500 was knocking on the door of a new all-time high. Three days ago, the NASDAQ was flirting with its bubble-induced high set some 15 years earlier. And three days ago, the Russell 2000 small-cap and the S&P 400 mid-cap indices were making new all-time highs and looking strong.

But then, seemingly out of the blue and without any obvious trigger, news event, new crisis, or headline, another selloff began. And then yesterday’s session turned into an all-out rout to the downside – again without any clear catalyst.

To be sure, the current market has been a herky-jerky affair for some time now. For the past four months, most trends have lasted between 5 and 7 days on average before reversing and heading the other way. Granted, there was the nearly month-long advance seen in February, which, of course, saw a quick reversal at the beginning of March. But the key is to recognize that the S&P 500 has now changed directions 8 times so far in 2015, 11 times in the last four months, and 15 times since the end of July.

What Gives?

There are any number of excuses provided by the popular to explain why the venerable Dow Jones Industrial Average, which now includes the world’s largest company, would suddenly fall 300 points. My personal favorite, however is “profit taking,” which was used with regularity yesterday. The problem is that this explanation tends to be employed when writers have absolutely no idea why the market just did what it did.

So let’s run down the reasons for the decline that were bandied about. First, there is the growing conflict in Yemen. And while this is not front-page news at the moment, fear of a geopolitical event involving Saudi Arabia could certainly cause a certain segment of the trading population to head for cover.

Next, although nobody wanted to say it out loud, concerns about the Germanwings plane crash being an act of terrorism have certainly been present. And we know for a fact that traders tend to sell first and ask questions later whenever there is an issue involving the killing of innocent people.

Moving away from the headlines and into the financial arena, the state of the earnings season continues to be an issue for some investors. By now, everybody knows that the strong dollar is going to hit the bottom lines of multinational companies, perhaps hard. The key here is that folks don’t know how bad the damage is going to be and as such, this brings some uncertainty into the market.

Next up is the issue of the U.S. economy. If you’ve been following the data, it has become abundantly clear that with the exception of the jobs reports, most of the economic reports have come in on the punk side so far in 2015. And while you can “blame it on weather” or the port strike in California, the concern is that GDP in Q1 is going to take a hit. But again, no one is exactly sure what that looks like at the present time and then perhaps more importantly, whether or not the slowdown in Q1 represents a trend. So, once again, this brings some uncertainty into the mix.

Speaking of the economy, there is also growing concern about the state of the consumer. Retail sales have been weak for months now and while a good part of the weakness seen here can be attributed to the decline in oil and gasoline, the key takeaway is that the U.S. consumer is not spending the savings generated by the decline in oil prices.

Correlated to the concern about the economy is the decline in interest rates. While the Fed is talking about hiking rates, the yield on the 10-year is once again going the opposite direction as one might expect. And with the 10-year yield now once again below 2%, there is concern that the worries about the economy may be warranted.

Stepping back from the blinking screens and the violent intraday action, there is also a fair amount of fretting on the valuations front. As pointed out in a recent missive, it is hard to argue that stocks are not overvalued on an absolute basis. And with some big-name investors having issued warnings on the subject, it is a safe bet that this remains a source of selling whenever stocks approach new-highs.

Then there is the idea of selling your winners at the end of the quarter. While this concept really only applies to the fast-money types, there is little doubt that the semis, the biotechs, and some of the consumer discretionary names (think retail) have seen outsized selling of late. You can blame it on hedgies all playing the same “rotation trade” at the same time or call it “profit taking” if you must, but the bottom line is that the proliferation of ETFs makes it easy for traders to hit just about any area of the market they’d like in a short period of time.

Speaking of the fast-money folks, I continue to believe that millisecond trend-following continues to have a huge impact on the market these days. In my humble opinion, it is the growing popularity of trading at speeds unfathomable to the human brain, that is causing the U.S. stock market to see exaggerated moves in both directions on a daily basis.

Do the math here and my point becomes abundantly clear. There are 1,000 milliseconds in a single second. There are 60,000 milliseconds in a minute. There are 3.6 million milliseconds in an hour. And thus, there are 23.4 million millisecond tick bars available to high-speed trend following algorithms each and every trading day.

This means that there is no need for these high-speed trend followers to hold positions overnight. Nope, each and every day brings the ample opportunity to jump in and out of the market at the speed of light. And so, when a strong trend develops in the market – with or without a reason – the trend-following algos simply chase each other higher/lower, exaggerating the move along the way.

So there you have it. While none of the above is really worthy of a 300-point decline on the Dow, the combination of issues just might be. And while I continue to believe that the high-speed trading is contributing to the outsized moves, the bottom line is that this volatile environment is showing no signs of letting up.

 

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