Beware a possible market topLast month, I posted an article here on TradingView in which I mentioned three indicators that 2020 might be a banner year for stocks. We had had a strong Santa Claus rally and a strong "first five days" of the year, I pointed out, and unless there was a major end-of-month correction, we were on course to have a strong January. All three of those indicators are highly predictive of full-year performance. Well, guess what? We got a strong end-of-month correction, and we ended January down 0.04% overall. That means we only got 2 out of the 3 bullish indicators, with overall January performance implying a bear year ahead.
Lately we've been rallying from that late January correction, but I'm not sure it can last. If China hadn't announced the removal of half its tariffs, the market would already have resumed a down trend due to growing coronavirus risk. The reality is that coronavirus impact is likely to be larger than the impact of a 50% tariff cut. Analysts are expecting 15% China production cuts in the auto industry, for instance, and oil prices already reflect a huge impact on travel and shipping. So far it's just international travel, shipping, and demand that are affected, but you can probably expect a larger impact on domestic markets within a month or two. My model suggests that the current global count of about 31,500 coronavirus cases is likely to grow to 190,000 by the end of February. (y = 126.23x2 - 1E+07x + 2E+11; R² = 0.999. See my Twitter page @WSPZoo for the graph.)
What might be the impact of coronavirus? Well, a quick review of a 2014 study on Spanish flu in Sweden-- where infection and mortality rates were similar to coronavirus-- suggests that capital returns fell by about 1%, and the poorhouse rate was about 11% higher in the hardest-hit areas than in the least-affected areas (due mostly to kids losing their parents). With the banking sector in the US currently very exposed to any increase in the poverty rate due to higher-than-2007-levels of subprime lending, I'd suggest coronavirus substantially increases the risk of another cascade of defaults like the one that triggered the 2008 Great Recession. The US also has a trillion-dollar deficit and low interest rates, leaving perhaps little room for fiscal stimulus if GDP growth should slow on the order of 1%. In short, this is very worrying.
The tariff news will buoy us a little, but I'm not sure how long it will last. If we end the day down today, then we will have made a bearish divergence on the RSI. And if we end the day down tomorrow, that'll probably give us a bear divergence peak on the MACD as well. I have already changed my allocation to about 75% cash, and it may be a while before I re-enter on anything but a few small option positions.
