US Stock Market Extremely Vulnerable to Renewed Selling in Asia

The major U.S. equity indexes finished higher on Thursday but the buying looked a little tentative. News out of China was the price driver again. Earlier in the week, Chinese officials calmed the nerves of global investors by pumping liquidity into the markets. This helped put a floor in the markets. With a support base in place, China was at it again on Thursday. This time driving prices even further away from this week’s lows by announcing it will halve tariffs on a slew of U.S. products.

In the cash market on Thursday, the benchmark S&P 500 Index settled at 3345.70, up 11.09 or +0.34%. The blue chip Dow Jones Industrial Average finished at 29379.77, up 88.92 or +0.31% and the technology-based NASDAQ Composite closed at 9572.15, up 63.47 or +0.69%.

What is the Price Action Telling Us?

After plunging last Friday then rallying to record highs this week, clearly we saw that U.S. investors are still in the “buy the dip” mode. This was particularly evident in 2019 when investors did not experience at least one 10% correction.

This week, the Dow and NASDAQ are both up at least 4% week to date while the S&P 500 has gained 3.8%, on pace for its biggest weekly gain since June. The major indexes all dropped at least 1.8% last week.

The price action also told us that most of the buying was being generated in pre-market sessions, which typically react to the price behavior in Asia and Europe. Although the U.S. indexes finished higher each day of the week, the intraday trading ranges were limited, which typically indicates tentative buyers.

In order to move forward with this bull market, we’re going to need to see the U.S. market lead the rest of the world instead of chasing Asia and Europe. Furthermore, if “buy low, sell high” become the marching orders then I expect to see a top when the euphoria from the People’s Bank of China’s (PBOC) wears off.

Analysts are Seeing the Same Price Action

While the newswires keep pumping out the headlines recognizing the record highs, the internals of the market suggest something else is going on. The price action may be indicating U.S. money managers are buying because of the fear they may miss the move. Furthermore, clearly, investors are ignoring the potential economic impact of the coronavirus too.

“The sling shot from last Friday’s lows has happened quickly, showing us that dip buying remains strong,” said Frank Cappelleri, executive director at Instinet.

Meanwhile, JP Morgan strategist Nikolaos Panigirtzoglou is not ready to sound the all-clear just yet.

“Despite this week’s equity market rebound we are reluctant to chase short-term momentum,” Panigirtzoglou said in a note to clients. “Instead we tactically trim the risk of our portfolio further and recommend a more modest equity overweight.”

“Although we recognize that the peak in the rate of increase in the number of new coronavirus cases appears to be behind us as containment measures thus far appear to have been effective, this could change as factories reopen in China and more people come in contact with each other,” said the strategist. “In other words, there is significant risk of an unexpected re-acceleration of new coronavirus cases.”

US Investors May Have Been Sucked into this Rally by China Government Stimulus

Although I typically follow “the trend is your friend’ theory when it comes to equities, I also believe that the best trends start in value area. This week’s rally did not. It was fueled primarily by the Chinese government pumping money into the system to prevent a meltdown in their stock market and to slow the possibility of an economic slowdown.

Furthermore, speculative buying and massive short-covering in Tesla stock single-handedly drove the NASDAQ Composite to a new all-time high. In my opinion, U.S. investors were trading momentum and not value. This usually indicates the presence of short-term speculative buyers, not value-seeking investors. I also think that some money managers bought because everyone was buying and they didn’t want to miss the move.

Additionally, China’s announcement that it was halving its retaliatory tariffs certainly came out of the blue. Although they claimed they wanted to move U.S.-China trade relations forward, I think it’s a sign that their economy is in trouble and is going to need the U.S. consumer to bail it out.

While not actually calling for a major top, I think this current leg of the stock market is over extended. We’ll know for sure when the Chinese stock market starts to sell-off. A steep break in Asia could bring the U.S. markets down because the recent rally in the region is what took it up.

Just to be clear where I stand, the rally in Asia took the U.S. stock market up this week, and the first sign of weakness in the region, will take it down.