After closing for a week, markets in China opened again last night. Stocks and commodities plunged as market participants tried to gauge the damage done to the Chinese economy by the fast-spreading coronavirus. There are over 17,000 cases now primarily in China as other countries around the world scramble to contain the problem.
China markets were down around 8% with many commodities, including oil, hitting the limit to the downside before bouncing. Saudi Arabia said it is considering cutting oil production by a million barrels to offset the softer demand created by the coronavirus shutdowns.
Officials in China are injecting liquidity that is equal to $173.8 billion into markets and they are also suspending short selling of stocks. Attempts to limit short selling have had dismal success when tried in the past, but clearly China is desperate to prop up its market and to prevent downside momentum from building. Central bankers are usually the most powerful in the market -- but in this case, the potential of economic damage is just too great and too uncertain to produce optimism.
Markets in Europe and the U.S. are seeing some mild bounces in the early going after suffering the worst losses in months on Friday. Market players are still struggling to price in the economic impact of the coronavirus. There is no real direct economic impact in the U.S. and other countries, but the issue is to what extent will there be a domino effect due to the sharp drop in China GDP.
Most market strategists appear to believe that U.S. markets have more downside from here for two reasons. First, the economic impact of the coronavirus on the worldwide economy is just too uncertain to fully discount at this point. There is no indication yet that the problem is contained. Second, the technical condition of the indices has deteriorated and the risk of a downtrend is growing.
On Friday, the S&P 500 (SPY) held almost exactly at its 50-day simple moving average at 3211. If that support is breached and there is a lower low, it will be the first time the S&P 500 has been under its 50-day moving average since early October.
The dilemma for traders is that the market has often been able to bounce back quite quickly from negative. Twice last week, the market bounced back strongly even as worries about the coronavirus expanded. The worries eventually took hold on Friday, but there was clear underlying support for most of the week.
Dip buyers tend to be quite persistent, but they will go away quickly when bounces fail. It is going to be particularly interesting to see how well this bounce holds Monday morning. Bears are likely to press at the first sign of red on the screens.
While the indices are in a very difficult position, there is some interesting technical action under the surface in small-caps. Small-caps have lagged for a while and are much cheaper on a relative basis compared to bigger-caps. This weak action should create some interesting entry points in stocks that are mostly immune to the coronavirus.
Alphabet (GOOGL) reports tonight and then the focus shifts to reports from small-caps until February 15. There should be some new opportunities in secondary stocks that have good reports but are under pressure due to overall market conditions.
My game plan is to look at pressing index shorts into a failed bounce in the next day or two. Also, I will be working on my shopping list and watching for entry points into individual names as this potential downtrend develops. There are many stocks that are not at all extended and are good value. A small group of bigger-cap stocks have distorted overall market conditions -- and therein lies opportunity.