David Moenning's Daily State of the Markets: 02/28

An Overreaction?

Good morning. After a day like yesterday, where the market’s scary plunge appeared to come out of nowhere, the key question on the average investor’s mind is, why did it happen? Was the biggest point drop since 9/11 caused by new economic data? Did something change in China to start another Asian Contagion? Do we have another currency crisis on our hands? Or, did the Fed announce that more rate hikes are on horizon?

While all of the above might have been decent explanations for a sudden drop of 416 points, the answers to these questions are no, no, no, no, and no. Simply put, what happened yesterday was a combination of technical action, something I call “hedge fund follies,” and emotion.

It is true that the selloff did begin in China. Word that the Chinese government had approved a task force to cut down on illegal investments was interpreted as an effort to curb growth in the mainland.

But, it is very important to understand that the Chinese government did NOT come out and talk about raising interest rates or changing the margin requirements or even enacting new laws to limit growth. No, this thing got started on “worry” that the main driver of BRIC growth (Brazil, Russia, India, and China), which in turn, has been a major driving force in the global economic boom, “might” slow down. And before you could look up the proper spelling of the Shenzhen 300 index, the thing was down more than 9%. Hmmm...

If the stock market in the U.S. had not been traveling in a straight line for the past seven months and if investor complacency had not been at such high levels, then this type of event might have caused a drop of 100 to 200 points because any time you talk about slowing growth there are concerns about the future. But, as we have mentioned time and time again, since stocks were very extended and the market had become a one-way street, the indices were set up for a correction.

However, the severity of the drop alone forces us to rethink the idea that this was just an overdue pullback. But, at the same time, we need to recognize that the decline of 416 on the Dow wasn’t exactly what it seems. Yes, part of the reason for the decline can indeed be attributed to worry over the future of the economy, which is thanks, in part to China and also Mr. Greenspan’s comments about the possibility of a recession.

But there is more to this story to take into account. You see, at 3:00 yesterday, the Dow suddenly, and without reason, plunged a quick 200 points. This set off all kinds of sell-stops as technical levels were obliterated and the unexplained move down also emboldened the bears to continue to sell short. The question though is what caused this instantaneous plunge?

While we will never know for sure, it looks like a combination of a huge option trade gone awry and the change at the NYSE to more computer oriented trading was to blame for the big dive. So, one has to wonder if part of the reason that a decline large to make every news outlet in America was technical in nature, should we be really be overly concerned?

Over the past 20 years, we’ve learned that when markets react emotionally, the drops tend to be fast, furious, and short – usually lasting anywhere from a few days to a couple of months. However, the really big declines involve a change to the fundamental outlook or a sudden realization that the game has changed. So, the most important question is, did anything change from a fundamental standpoint?

In short, it is my humble opinion, that this move was more emotionally oriented than fundamentally driven. And while I will keep watching closely and I do reserve the right to say I was wrong, I’m going to bet that this will wind up being a short-lived affair.

The key going forward will be to watch both teams’ reactions over the next few days. If, as I suspect, this was more emotion than fundamental, then the bulls ought to make an attempt at a rebound in fairly short order. And it will be the strength of the rebound that will be the key “tell” as to the near-term direction.

Turning to this morning, the government’s second try at the Q4 GDP numbers provided some good news on the inflation front. While the headline GDP came in a little light, the Core PCE, which is one of the Fed’s favorite inflation components, was reported at 1.9% versus expectations for 2.1%. And so far at least, this appears to be music to the bulls' ears.

Running through the pre-game indicators, the major overseas markets were lower again overnight. Gold futures are trading lower by $11 this morning to $676.10 right now. In the oil pits, crude futures are up $0.68 this morning and the latest quote is at $60.78. Interest rates are moving higher this morning as flight to quality appears to be abating. The yield on the 10-year is currently trading at 4.55%. And finally, with about an hour before the bell, stock futures in the U.S. are looking to open up nicely. The Dow futures are currently up by about 85 points; the S&P’s are about 12 points above board, while the NASDAQ looks to be about 9 points above fair value at the moment.

Stocks “In Play” This Morning:
Liz Claiborne (NYSE: LIZ) – Reported $0.94 vs. $0.97
Merck (NYSE: MRK) – Guides Q1 Earnings to $0.63 to $0.67 vs. $0.60
Public Storage (NYSE: PSA) – Reported $1.08 vs. $0.93
Sprint Nextel (NYSE: S) – Reported $0.29 vs. $0.29
Wynn Resorts (Nasdaq: WYNN) – Reported $0.53 vs. $0.47
BEA Systems (Nasdaq: BEAS) – Upgraded at Bear Stearns
Reliant Energy (NYSE: RRI) – Downgraded at CIBC World Mkts
Federal Natl Mortgage (NYSE: FNM) – Upgraded at Friedman Billings
American Express (NYSE: AXP) – Upgraded at Friedman Billings
Posco (NYSE: PKX) – Downgraded at Goldman Sachs
Boeing (NYSE: BA) – Upgraded at JP Morgan
Lockheed Martin (NYSE: LMT) – Downgraded at JP Morgan
Ciena (Nasdaq: CIEN) – Upgraded at JP Morgan
Bear Stearns (NYSE: BSC) – Downgraded at Merrill Lynch
Goldman Sachs (NYSE: GS) – Downgraded at Merrill Lynch
Lehman Bros (NYSE: LEH) – Downgraded at Merrill Lynch
Research in Motion (Nasdaq: RIMM) – Upgraded at Think Equity

Mr. Moenning holds Long positions in stocks mentioned: BSC, GS, RRI, PSA, LMT

Note: All earnings reports compared to Reuter’s consensus estimates

** For More of David Moenning’s Market Analysis, Stock Portfolios, and Trading Ideas, visit: www.TopGunsTrading.com

The opinions and forecasts expressed are those of David Moenning, President of Heritage Capital Management and Co-Founder of TopGunsTrading.com and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security or Heritage Capital program. No part of this material is intended as an investment recommendation. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any of HCM’s programs. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that investment objectives outlined will actually come to pass. Investors should consult an Investment Professional before investing in any investment program. Neither Mr. Moenning or Heritage Capital Management nor any of their employees shall have any liability for any loss sustained by anyone who has relied on the information contained herein. Mr. Moenning and employees of HCM may at times have positions in the securities referred to and may make purchases or sales of these securities while this publication is in circulation. The analysis contained is based on both technical and fundamental research. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

You May Also Be Interested In

• After-Hours Movers: AMAT, DLO, GLOB, YSS, ETON
• After-Hours Movers: CSCO, COHR, HLIT, CBRS, STUB, ENS
• After-Hours Movers: P, RIOT, BW, RKLB, HIMS, UPWK