For the last three weeks, the market has held up remarkably well as China has grappled with coronavirus. Market players have justified the strength and the all-time high hit last Wednesday on the basis that the problem was mostly contained to China and that aggressive central banks would help to battle the problem with aggressive action. Many market players were uncomfortable about the strength, but they were willing to believe that the market strength indicated that maybe the problem was under control.
That positive narrative started to shift on Thursday. There were reports of coronavirus in South Korea and Italy and the distrust over the data coming out of China started to grow. The unease picked up on Friday, but there were still few signs that there was any significant spread outside of China.
On Monday morning, panic is building as the number of coronavirus cases in South Korea and Italy jumped. In addition, there are now cases in countries that previously had none reported. There is still no significant pickup in cases in the U.S., but there are concerns about how much actual testing is being done.
On top of the coronavirus concerns, Bernie Sanders has emerged as a leading candidate for the Democratic Presidential nomination. While many think he will not be able to beat Donald Trump, it is a concern for the market that someone that views it in such a negative way has such a large constituency. Much can and will happen as the election unfolds, but there is a large faction of voters that want to change the way the economy and stock market operates -- and it not likely to benefit investors.
The big question that market players must contemplate is whether the very large drop that is occurring Monday morning is going to attract some dip buyers or whether it will to finally create some real fear. Dip buying has been automatic and routine for quite a while, but, as I discussed on Friday, the character of the action was shifting and now the likelihood of further downside is quite high.
There are a couple of things to keep in mind as you navigate this action. The first is that this has been a narrow market for a while with a small group of big-caps driving the indices. Microsoft (MSFT) , Apple (AAPL) and a few other names have driven most of the gains in the indices. Under the surface, about 43% of stocks are already under their 200-day simple moving average. They are not at all extended. Microsoft would have to drop all the way to $145 -- a drop of over $30 -- before it would test its 200-day simple moving average.
This may ultimately be good news for stock pickers eventually, but in the short term, this sort of selling tends to be highly correlated. When there is panic like we are seeing this morning, everything is sold together. There is little consideration of valuations when people are trying to escape a sudden bout of panic.
Eventually, the selling will slow and market players will start to look at stocks based on their individual merits, but that is not going to be the case this morning.
The key to the market action now is watching for failed bounces and lower lows. If the panic selling this morning is leading to a meaningful downtrend, then the bounces will be sold and the lows will not hold.
Bulls will be looking for central banks to ride to the rescue, but the bears are already arguing that the bankers can throw money at the market but they are powerless to stop the virus and the impact on supply chains around the world.
Many market players have been anticipating some severe corrective action for a while. They have it this morning and that isn't a bad thing as a new crop of trading opportunities is going to quickly emerge. Buckle up, it's going to be a bumpy ride.