This week has been a worrying one for investors. Futures are indicating a bit of a bounce back early this morning and if that holds, the net effect of the last five days’ trading will not be that bad, with the S&P 500 losing only around one percent on the week.
What is concerning is in part the way that has happened, with volatility increasing again, and in part what is happening in other markets, with Treasury yields dropping and oil posting some big losses.
Given that, the fact that stocks have held up well can be taken as a good sign, but there are some things that should be watched closely right now for signs of more trouble to come. Here are four things to keep an eye on.
Key Levels for the S&P 500: As I said, stocks have shown some resiliency, but the S&P is now close to some important technical levels.
Just before the run up to new highs, the index hit a low of 2785.02 in March. As part of a retracement on the way up that level has little real significance on its own, but, as you can see from the chart, 2785 (yellow line) is now very close to the 100-day moving average (blue line).
A move down of only around 1.5% from yesterday’s close would bring 2785, into play, and a break of that would make for a very bearish technical picture.
Credit Markets: As stocks bounce a bit this morning, the yield on the 10-Year Treasury note is also recovering, but for those that believe that the best indicator of potential trouble in stocks comes from the bond market, it has been a week of worry. Not only did the 10-Year hit new lows for the year, but there were declines in yields all the way out to the “long bond”, the 30-Year U.S. Government bond.
As that happened, we once again saw the ten-year yield fall below the one-year, something that is generally seen as a sign of impending recession, and bond futures are pricing in multiple rate cuts from the Fed over the next year, another bad sign.
However, so far it isn’t all bad news from bonds. High yield, the riskiest bond market and therefore the most sensitive to economic conditions, held up well. HYG, the iShares High Yield ETF finished the week essentially flat. That is the thing to watch. The moves in Treasuries are distorted by the Fed’s actions and the market’s expectations for them, but if junk bonds start to drop noticeably it would signal a return of a risk-off environment really taking hold.
Oil: The price of oil can be an indicator of global economic prospects, but some care should be taken as there are a lot of factors that affect crude pricing. This week’s big drop, however, came as some of the others, tension in the Middle East and a still tight supply picture for example, offered support.
It is therefore logical to conclude that the declines were about concerns about global growth, and in particular about the effects of the ongoing trade war. In that regard, oil is the canary in the coal mine, and a further fall in crude prices could be a warning sign.
Brexit: I have said in the past that U.S. investors should be more worried about the political chaos in the U.K. than the stock market suggests they are. If there is a “hard” Brexit, whereby Britain leaves the E.U. with no trade or other agreements in place, the disruption to the U.K. and E.U. economies could have serious effects that spill over to the rest of the world.
Theresa May’s resignation this morning comes as no surprise given the failure of her exit plan but if she is replaced by a hardliner such as Boris Johnson, a hard Brexit looks much more likely. The internal politics of a party thousands of miles away may not seem that significant, but developments in that leadership battle should also be watched closely.
Right now, U.S. investors shouldn’t be panicked into any drastic action by the market volatility. We have been through this several times on the way up, and no market ever moves in a straight line. There are, however, signs that things could get significantly worse, and keeping track of the four things above will give you a heads up if that is about to happen.