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5 Key Takeaways From Last Week's Historic Drop

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The selling we saw this week was one for the ages. Yes, I've been extremely bullish for a long time and it's primarily because of the economic environment. There's never been a time when we've been looking at moderate growth, historically-low interest rates AND the opportunity for the Fed to further lower those rates. The inability of inflation to even keep pace with the Fed's moderate 2% target has given them a blank check to keep interest rates low for the foreseeable future. Last week's nearly unprecedented drop in global equity markets provided them an entire checkbook.

So, after picking up the pieces during the aftermath of a very rough week, here's a handful of key takeaways for me:

Gaps were king

The ETF (SPY) that tracks the S&P 500 closed on February 21st at 333.48. One week later, it closed at 296.26. That represents a drop of 37.22 points. You might be surprised to know that opening gaps accounted for 22.14 points to the downside, while actual selling during the trading days accounted for the other 15.08 points lower. I'm not sure how anyone else interprets this, but it appears the coronavirus was worse while the U.S. stock market was closed.

To put this another way, 59.48% of the loss this past week occurred when the opening bell rang. The fear mongers certainly got what they were looking for - panic. Someone was clearly buying throughout the trading days last week. Was it you? It wasn't me. Don't be surprised to see the stock market rally next week now that certain pockets have been lined with shares.

The talking heads are all comparing the fear this week and the drop from the coronavirus to the financial crisis of 2008. Puh-lease! That was true panic, a near-financial system collapse. From the October 3rd, 2008 close to the October 10th, 2008 close, the SPY took a massive tumble. Opening gaps lower accounted for just 24.47% of that week's loss (compared to 59.48% losses from opening gaps this past week). The overwhelming majority of the selling (75.53%) occurred during the trading day. THAT was true panic and REAL SELLING in a dire environment.

The coronavirus is a serious health risk, but I doubt its impact will rival the trillions of dollars lost in equity markets over the past week. Maybe I'm wrong.

Powell is no pal of Wall Street

I've been highly critical of our Fed Chief in the past, so I won't spend a lot of time on this. But I'm quite certain Ben Bernanke would not be sitting back, saying the central bank is "prepared to act as appropriate." Jay, just look at this chart of the 10-year treasury yield ($TNX):

The bond market believes a 50 basis point rate cut would be appropriate immediately. But take your time Jay. After all, it took the better part of a year for the Fed to get it right with respect to the trade war. #worstfedever

Growth stocks lead value stocks

Ok, now this one was a huge surprise. In a market environment where earnings growth will be drastically cut, wouldn't it stand to reason that those stocks that crushed the benchmark S&P 500 in 2019 and 2020 would have their legs cut out from under them now? The Russell 2000 Growth ETF vs. the Russell 2000 Value ETF (IWF:IWD) gained ground last week:

Huh? In Q4 2018, when our GDP growth slowed dramatically, the IWF:IWD ratio tumbled (red circle), as I would expect. Why, with all the lowered earnings revisions and dire economic forecasts, would growth stocks outpace value stocks last week? Something doesn't smell right.

Software breaks out to new relative high

How can this be? Didn't Microsoft (MSFT) just issue a revenue warning? Check out how the software group performed vs. the S&P 500 ($DJUSSW:$SPX) on this 3-year relative strength chart:

Makes sense, right? We're on the cusp of a massive economic disruption and the aggressive software space ($DJUSSW) breaks to a new all-time relative high vs. the S&P 500. When the stock market recovers, this remains an area where you want exposure - in my opinion.

Biotechs avoid a closing breakdown beneath January low

Here's another group that you'll want to keep a close eye on. Yes, they once again failed on their recent absolute breakout, but how could they not, given the selling over the past week? More important is their relative strength, which broke out last week to a 10 month high. Check it out:

I believe that, when 2020 is all said and done, biotechs ($DJUSBT) will be among the leading industries.

In conclusion....

If you can't tell, I don't trust Wall Street and I don't trust the media. Wall Street will make money at your expense and mine every single time. And if you believe every story out of the media, I have a bridge to sell ya.

I don't know how the coronavirus will impact the global economy, I wish I did. But I do believe it's a one-time drop in the market and we'll set sail right back on our secular bull market course once it's behind us. And that's also what many of the key takeaways above are telling me. We may not have seen the low yet, because fears will run rampant again, I'm sure, as we count coronavirus cases one by one. The Fed, however, will act very soon to lower rates and sentiment will turn, even if only temporarily. Friday's low was marked with a VIX reading near 50. Historically, extreme sentiment readings mark bottoms. We'll see if Friday marks a major low this time. Even if we bounce next week, I would expect we'll eventually see a test of Friday's low, perhaps even one more low.

I don't watch CNBC any more. I'm not kidding. Not ever. It clouds my vision. I can't recall the last time I actually put CNBC on my TV. I'd guess it's been at least 3-4 years. Let the charts and common sense do the speaking, not the clickbait headlines from the media.

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Happy trading!

Tom

Tom Bowley
About the author: is the Chief Market Strategist at EarningsBeats.com, where he provides stock market education, guidance, and trading strategies using a unique combination of technical, fundamental, and historical analysis. Tom provides EarningsBeats.com members with four portfolios (Model, Aggressive, Income, and Value), all designed to beat the benchmark S&P 500, and a revolving Watch List of hundreds of companies reporting strong quarterly earnings (must beat both revenue and EPS estimates) and exhibiting technical strength as well. These companies comprise EarningsBeats' annotated Strong Earnings ChartList (SECL), from which Tom trades exclusively. Tom writes a Daily Market Report (DMR) for members to include an executive summary, market outlook, sector/industry watch, and trading ideas. Learn More
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