Download the PDF version of this Educational Series.
Selling activity in global equity markets has accelerated over the last three trading days, in a chain of events that commenced with last week’s Federal Open Market Committee Meeting (FOMC). The Fed delivered an expected quarter-point rate cut, but investors found Fed Chair Jerome Powell’s comments about the cut to be bearish. Powell described the rate cut as a “mid-cycle adjustment”, rather than the beginning of a sustained easing cycle. This seemingly hawkish characterization cast uncertainty over the path of future FOMC meetings and triggered selling in the equity market and buying in the debt markets. The mini-tantrum over the FOMC meeting was just the beginning however, as President Trump escalated the trade war with China – in 280 characters or less – with a surprise tweet announcing fresh 10% tariffs on $300 billion worth of Chinese goods effective September. Prior to President Trump’s tweet, the trade negotiations had been progressing slowly but seemingly amicably, but the antagonistic nature of the unexpected tariffs caused China to quickly promise retaliatory measures, such as stopping purchase of our agricultural products and weakening their currency versus the dollar. Markets sold off aggressively Friday and picked up on Monday with a decline of -2.98% in the S&P 500.
Prior to this selloff, equity markets were enjoying a slow, steady uptrend marked by low volatility. Equity signals utilized by Hanlon identified the positive trend across all sectors aside from Energy and our clients have been fully invested for most of the year as equities have trended higher. However, our research into historical equity market behavior tells us that periods of low volatility can often mask underlying risks. Therefore, we build our tactical trading signals with additional overlays intended to detect such risks, as the first and foremost objective of our Tactical strategies is to protect our investors from steep market declines whenever possible. In this instance, despite the positive market trend exhibited by most equity sectors, we noticed a concerning pattern to the underlying equity market breadth.
As the S&P 500 Index has been pushing higher in recent months, the underlying data shows signs of deterioration beneath the surface. Namely, the number of stocks participating in this ascension to new highs has been steadily declining. As the below chart shows, there is a clear divergence that triggered concern within our signals that the rally in the markets might be unsustainable. For the market to continue to reach new highs on the back of fewer stocks tells us that it was a minority of mega-cap stocks propping up the larger market. The lack of market breadth caused us to sell out of most equity positions in our clients’ accounts prior to Monday’s steep selloff, thereby lessening the pullback.
This past week’s events have added a great deal of uncertainty to the markets. Uncertainty is public enemy number one on Wall Street, and it looks like the current uncertainty may linger for some time. The trade war is clearly driving the market, as it has for over a year now. Yet, judging from the economic data, the effects have barely registered on the US economy. The Fed dual mandate of growing jobs and managing inflation remains on target, with unemployment at a 50-year low and subdued inflation. Corporate earnings have also been solid, although the bar for this quarter had been lowered as many companies reduced guidance under the threat of a prolonged trade war. Finally, from a technical perspective, there is strong support for the S&P 500 around the 2,800 level which marked prior support and resistance levels and coincides with the 200-day moving average. We will be closely monitoring these indicators, and many others, to gauge whether we are in the midst of a temporary pullback or if this is the first wave of a larger drawdown.
Past performance is not a guarantee of future results. This Educational Series is limited to the dissemination of general information pertaining to its investment advisory services and is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock and bond markets involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice. Hanlon has experienced periods of underperformance in the past and may also in the future. Hanlon Investment Management (“Hanlon”) is an SEC registered investment adviser with its principal place of business in the State of New Jersey. Hanlon and its representatives are in compliance with the current registration and notice filing requirement imposed upon registered investment advisers by those states in which Hanlon maintains clients. Hanlon may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements. Any subsequent, direct communication by Hanlon with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Hanlon, please contact Hanlon or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Hanlon, including fees and services, send for our disclosure statement as set forth on Form ADV from Hanlon using the contact information herein. Please read the disclosure statement carefully before you invest or send money. Not all Hanlon clients are in the strategies discussed herein.