The past couple of trading weeks underscore the importance of sentiment and positioning. Stocks peaked on February 19. At this point, the bull market seemed unstoppable due to months of a relentless advance with brief periods of consolidations. Market sentiment and positioning reflected this - bears were slaughtered; retail traders were piling into some of the riskiest stocks; calls were accumulated; cash balances were at a record low; and margin balances were at record highs. Interestingly, the last month of the advance featured an alarming divergence as cyclical indicators were weakening.
Creating the Conditions
While sentiment is a poor timing tool, it's' useful to gauge the potential move in any direction. It basically means that everyone is one side of the boat. If there is a disturbance or shock of any sort, it can unleash tons of volatility since everyone is already long. This is basically what happened over the last seven trading sessions as the S&P 500
Of course, the catalyst for the drop was the coronavirus spreading to multiple parts of the world, and it's become increasingly clear that it will have a large but uncertain impact on economic activity and corporate earnings for the rest of 2020. Due to this steep drop, the market is now severely oversold on a short-term timeframe by many measures. However, while the virus was the cause, factors like sentiment, positioning, and slowing growth created the conditions that made stocks vulnerable.
Oversold Market
In fact, the market is now anticipating 50 basis points of rate cuts by the March meeting and another full basis point of rate cuts before the year is over. In the S&P 500, more than 90% of stocks are now trading below their 50-day moving average. Treasury yields continue to tumble as the 10-year approaches the 1% mark.
Given the extreme selling, some sort of bounce is likely in the coming days especially given the short-term extremes that stocks hit. Some potential catalysts include progress in fighting and containing the virus, global coordinated central bank action, or some breakthrough vaccine to inoculate against it.
Markets can have "V-shaped" bottoms like December 2018, where they simply melt-up to new highs and never give anyone really a chance to buy the dip. However, they can also take months to bottom. In this case, the latter is more likely. Fiscal and monetary stimulus can offset the effects of the coronavirus, but it can't actually fix the underlying problem.
