Why Monday's stock market crash should be a wake-up call for investors

Monday’s punitive selloff could be the start of the next move lower in stocks as complacency sets in after a stellar October and November, several strategists told MarketWatch.

In a note to clients on Monday, Jonathan Krinsky, chief technical strategist at BTIG, said U.S. stocks are poised to fall behind the S&P 500

bounced off its last resistance level, which coincided with the index’s 200-day moving average, a key technical level for the asset. Krinsky illustrates the model in a diagram included below.


“Investors have become too complacent as the SPX gives up its long-standing downtrend resistance, just as it did in March and August,” Krinsky said in comments emailed to MarketWatch.

Other market strategists agreed with that warning, but explained that the complacency was a result of the market’s powerful relief over the past six weeks.

Katie Stockton, technical strategist at Fairlead Strategies, said the latest pullback in stocks was “a sign that the market is fragile, and that’s reasonable given the length and scale of the relief.”

Ahead of Monday’s session, the S&P 500 had rallied more than 16% from intraday lows hit on Oct. 13, the day the stock made a historic turnaround after the release of hotter-than-expected September inflation data.

After the release of the November jobs report on Friday, stocks fell again on Monday, with the S&P 500 and the Nasdaq Composite Index

recording its biggest retreat since Nov. 9, according to Dow Jones market data. The Dow Jones Industrial Average

and Russell 2000

also sold out sharply.

Look: Here’s what the story says about the stock market’s performance in December

The VIX reflects a false sense of security

Traders’ sense of security is reflected in the CBOE Volatility Index
otherwise known as the “VIX” or the “fear gauge” on Wall Street, according to Nicholas Collas, co-founder of DataTrek Research.

Often a contrarian, the VIX reaching below 20 should have been a warning sign to investors that stocks were vulnerable to a selloff, Colas said in an email to MarketWatch.

“Markets have simply been too complacent about policy uncertainty and what 2023 holds for corporate earnings. When we get below 20 VIX, it doesn’t take much to turn the markets around,” Collas said in an email.

But as Colas explained, historical patterns have helped drive the VIX’s remarkably low level over the past few weeks.

In theory, seasonal patterns dictate that the stock rally should continue through the end of the year, as MarketWatch reported last week. Stocks typically rise in December as liquidity dries up and traders avoid opening new positions, enabling what some on Wall Street have called a “Santa Claus rally.”

Whether that pattern holds this year is murkier.

As Colas explained in a note to clients on Monday, the main concern for stocks right now is that investors are overlooking the risks of further downward revisions to corporate earnings expectations, as well as other potential downsides from the looming recession that many economists think likely.

Of course, economic data released in recent days point to a relatively stable US economy in the fourth quarter. Jobs data released on Friday showed the U.S. economy continued to add solid jobs in November, despite reports of widespread layoffs by technology companies and banks.

The ISM barometer of services sector activity released on Monday rattled markets, coming in stronger than expected. All of these data have raised concerns that the Federal Reserve will need to deliver even more aggressive rate hikes if it hopes to succeed in its battle against inflation.

More aggressive interest rate hikes could, in theory, provoke a “hard landing” for the economy.

Have falling government bond yields reached a point of diminishing returns?

As BTIG’s Krinsky explained, complacency is not unique to equity markets. Bond yields have also fallen more than BTIG expected, he said in a recent note to clients, perhaps more than warranted by the uncertain outlook for both monetary policy and the economy.

Because the yield on the 10-year Treasury bond

peaked above 4.2% in October, falling government bond yields helped prop up a range of risk assets, including stocks and junk bonds. The yield on the 10-year note, considered by Wall Street to be the “risk-free rate” against which stocks are priced, was just under 3.6 percent late Monday. Yields move inversely with bond prices

Even if yields continue to fall, the dynamic in which lower government bond yields help boost stock prices may have reached a point of diminishing returns, Krinsky explained.

“While we think this level is holding, we wonder if a break below 3.50% would be seen as favorable for equity…[w]I have some doubts,” Krinsky said in a note to clients.

Wall Street economists expect the recession to begin sometime in 2023, an expectation supported by a sharply inverted government bond yield curve, which is seen as a reliable indicator of a recession.

All of this has investors keeping a close eye on US economic data for the rest of the week. A report on November producer price growth, due on Friday, could be another major catalyst for markets, strategists said.

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