Yesterday was lesson in investor psychology. The confidence factor has been slipping the last six weeks as the economic data showed signs of slowing in the U.S. The consumer confidence number announced yesterday morning showed a drop from 62.8 to 52.9 leading to the selling. Some of the blame was given to China and the slowing in their economic data. It all comes down to confidence towards the economy looking forward. Will it grow at a pace fast enough for earnings to grow along with stock prices?
The psychology lesson comes in understanding what makes investors react in unison on a day like yesterday. The catalyst was the news from China’s LEI data in combination with the consumer confidence data in the U.S. They were not the cause, that honor goes to investor confidence. Without repeating all the data points over the last six weeks each one had a hand in chipping away at the confidence in future growth. Jobs report, same store sales, monthly sales, ISM manufacturing, etc. Each took a chip away until the investor finally decided the risk/reward relationship doesn’t warrant being invested in stocks. The flight to quality begins with each chip and then accelerates the selling.
The Treasury bond yields gave another warning sign. The yields on the Treasury bond just eight weeks ago was at 4%. It has slowly declined on a flight to quality. The European worries started the movement and each data point has push more money in that direction. The flight to safety puts emphasis on the risk aversion by investors. Yesterday the 10 year bond fell to 2.96%, breaking below support. This is not a good sign looking forward for stocks. Psychologically the investor is throwing in the towel on risk.
The lesson is how investors migrate towards taking risk out of their portfolio. The data builds a case for the downside and in turn selling builds momentum. This is why stops keep you in line with the market direction. As the market drops the stops are hit and cash becomes your largest position. The downside trend will also begin to develop technically as lower low and lower highs are established. Support lines are broken and momentum gains in the selling. Thus, the ability to put money to work in being short stocks. Investor sentiment plays a big role in trend development and trend reversals.
Are we to conclude the investor is done and the downside is in control? No one knows for sure what will happen from this point forward, but we can see what we are looking at technically and fundamentally. First, technically support lines are the talk of the town. 1040 on the S&P 500 index has been on every billboard the last four weeks. We broke that level intraday yesterday. How the investor reacts to that will be see in the next couple of trading days. Thus, like everyone, we will watch to confirm the break below this level if the momentum continues lower. It may bounce and then retest this level on a news event in the future. I am watching the jobs report on Friday. Second, fundamentally the economic data is putting a big question mark around the outlook for second quarter earnings. More importantly the outlook for the second half of the year is being revised lower for growth. GDP is expected to be between 1-1.6% growth and some think that is optimistic. The impact the earnings will be an issue as revisions are made and pessimism creeps into the financial markets. Not the best of scenarios relative to stock growth.
As you can see the market data and the investor go hand in hand in determining direction of the market. Our job is to pay attention, listen to both the data and the investor and invest accordingly. We have talked many times in the past on the importance of a defined entry (strategy), a defined stop (risk management) and a define target (goal). Sound money management takes into account the probability of being right or wrong on every position in your portfolio.
This promises to be an interesting period looking forward, but the bottom line is – protect your assets. Risk management is the priority.