Update: Stocks Resilient After Japanese Sell-Off

U.S. stocks opened sharply lower following a major sell-off in Japanese equities overnight, continued fears over Fed tapering, and weak Chinese economic data. However, encouraging home sales data helped stem additional pressure in this incredibly resilient market. Interestingly, from yesterday’s all-time high to today’s low is already a 3% correction nearly matching the worse drawdown of the year on the S&P 500.

As of 10:25AM, the S&P 500 is trading at 1,645, recovering from its lows of 1,635 shortly after the open. 1,635 and 1,600 are the key levels to watch (formerly resistance, now support). We easily held the 1,635 support level earlier, and have already recovered nicely.

Major Areas Of Focus Today:

Technical Trend Reversal – On a technical front, yesterday was a critical day, as we printed an enormous bearish outside reversal on the charts (hitting higher highs intraday, but closing lower than previous day). This has a lot of investor’s attention, as it potentially signals a trend reversal at the same time the markets hit fresh all-time highs. The very frightening statistic that’s been making the rounds overnight is that the last two times the S&P 500 touched a record intraday high and then closed down more than 1% from that high were October 11, 2007 and March 24, 2000, the last two major tops for the market, both of which occurred before historic crashes.

– Japanese Equities Plunge – Asian markets were thrashed in overnight trading. The Japanese Nikkei 225 plummeted a staggering 7.3%, the Hang Seng dropped 2.5%, and the Shanghai Composite shed 1.1%. Japan’s Nikkei imploded, down over 1,100 points, with every constituent declining – not seen since April 2005. To put things in perspective, however, the Nikkei was up over 6% last week alone.  Last night’s drop only knocks YTD gains down from 50% to 40%, so this move lower in the context of the mega rally is relatively minor.  More concerning to market participants was the surprisingly sharp rise in Japanese bond rates. The 10-year JGB yield surged 14 basis points to over 1%, prompting the Bank of Japan to step in and buy ¥810 billion yen ($7.94 billion).

– Weak Chinese Economic Data – Exacerbating the Asian sell-off was a very ugly flash PMI number out of China, which unexpectedly fell to 49.6 in May from 50.4 in April. Any number below 50 on the PMI indicates contraction, so the reading suggests that China’s manufacturing sector is now contracting.

– Better-Than-Expected Weekly Jobless Claims and Home Sales Data – Initial jobless claims, a close proxy for layoffs, dropped by 23,000 to a seasonally adjusted 340,000 in the week ended May 18. Oddly enough, the better-than-expected jobs data was perceived as bad news for equity markets, as it bolsters the expectations that the Fed could taper back its accommodative policies with an improving employment picture. All eyes will be on the all-important NFP report in two weeks, which could justify Fed tapering. Housing data continues to be a bright spot, as sales of new U.S. homes edged up in April to the second-highest post-recession level, as pent-up demand, low interest rates and tight inventories of older homes lifted demand.

– Currency/Commodity Volatility – The Asian sell-off prompted investors to look for safety, triggering a flight to quality rally in the Treasury market. U.S. government bond prices rose, pushing the yield on the 10-year note down 5 basis points to 1.996%, helping the benchmark debt recoup part of its 10-basis-point loss yesterday. Perhaps most interesting, however, is the sell-off in the dollar, which typically is seen as a safe-haven in volatile markets. Benefitting from the dollar weakness are both gold and the Euro. The euro is back up to $1.2903, up from $1.2850, while gold is up over 1% attempting to re-test the $1,400 handle.

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