The Market is Sending Mixed Messages: What Should Investors Do?

Yesterday morning, before all the action started, I wrote this piece, pointing out that the weekly unemployment claims number was a lot weaker than it first appeared, and that the negative pre-market reaction to what looked on the surface like a good number showed that the market understood this. There was a distinctly bearish tone to all that, but not even I expected to see this is the S&P 500 E-Mini futures contract once the main session got going:

That is a good old-fashioned selloff. The last time we saw a drop in the S&P of that magnitude was on June 11. Looking back, that big drop was an opportunity, so will this be the same? Or is it more like what we saw in late February, when a similar decline was the start of a major correction?

The two most important factors in making that determination are the cause of yesterday’s selloff and its nature.

Without the ability to read thousands of minds simultaneously, we cannot know the cause for sure, but the timing of it suggests that it was at least in part in reaction to those weak jobs numbers. As I pointed out yesterday, that was data for last week, whereas the much more encouraging monthly jobs report that came out this morning is for a period that ended halfway through last month.

Since that period covered by this morning’s data ended, we have heard in the Fed’s Beige Book that many regional Fed Chairs see weakness in their economies that sounds worryingly like it could be a lot more persistent than was first assumed. In today’s topsy-turvy world, of course, when that came out on Wednesday, the Fed’s gloomy take was seen by traders as increasing the chance of yet more stimulus, both monetary and fiscal, so it powered stocks to another new all-time high.

What we saw yesterday, though, was a reaction to data that seems to suggest that maybe the Fed is right, and that whatever they or Congress do, the economy is still suffering. Traders seemed to be finally acknowledging that maybe there will not be a sharp bounce back in the economy to match that of the stock market.

That is a worrying sign, but solace can be taken from the nature of the selloff.

It was focused on big tech names. That is not good for those for whom big tech comprises a significant part of their portfolio (a group that includes me, by the way) but in the grand scheme of things, it is actually a good sign. That is the area of the market that has shown the strongest gains for some time now, so selling there looks more like an overdue adjustment than a cause for major concern.

Ultimately, though, the real test of whether yesterday’s action is a small, temporary, needed correction or the start of a lasting period of volatility will come today. The reaction to this morning’s much more encouraging, if backward looking, jobs report has maintained the pattern of yesterday. Nasdaq is still down after the numbers, while the Dow is up. If that holds, then yesterday looks more like a technical adjustment than a warning sign. If, on the other hand, industrial, manufacturing and other more traditional sectors turn around as the day goes on, it would be a worry for the broad market.

On balance, then, right now it looks more likely that yesterday’s big decline in stocks was more along the lines of a short-lived, much-needed retracement than the beginning of a major correction. However, any significant selling during the day today would negate that view, and with a holiday weekend coming up, that could be a major risk. So, for now, I will be staying hedged and protecting against a bigger move.

In my case, that means a small short position in S&P 500 futures. That may not suit you, but even so, you might want to consider a small position in something that would benefit should the drop prove to have some legs, something like an inverse index or VIX ETF. That would have the advantage, not just of making money on the way down, but more importantly of making it easier to stick to your long-term investing strategy. Selling everything in a panic is a lot less likely when you can tell yourself you saw a drop coming and are making a profit somewhere.

As I said, the jury is still out on whether yesterday’s drop was an anomaly or a harbinger of doom, but for now, risking a small loss to protect against further declines look like a smart thing to do.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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