What’s Behind the Market Weakness?

Stocks finally run into volatility… three reasons for the turbulence, from our technical experts… reviewing this week’s flash crash in the crypto market

As I write Friday late-morning, we’re on pace for five straight days of losses.

Given how strong the market has been this year, a bout of sustained weakness like this feels especially disconcerting.

So, what’s behind the volatility? And what does it mean looking forward?

Today, we’ll get answers from our technical experts, John Jagerson and Wade Hansen.

We’ll also pivot to Luke Lango’s analysis of the flash crash we saw in the crypto sector earlier in the week. It’s all related, as you’re about to read.

Lots to cover, so let’s jump right in.

***A surprise spike in bond yields leads to some nervous traders

For newer readers, John and Wade are the analysts behind Strategic Trader. This premier trading service combines options, insightful technical and fundamental analysis, and market history to trade the markets, whether they’re up, down, or sideways.

Returning to this week’s “down” market action, let’s start with what happened with the 10-Year Treasury yield.

From John and Wade:

We were surprised to see yields jump on Tuesday, which triggered the back and forth selling.

As you can see in the following chart, the 10-year treasury bond yield spiked to 1.4% on Tuesday.

The word “spike” is overstating the case, but anytime interest rates rise by more than 4-5 basis points we tend to see a knee-jerk reaction in stocks.

It appears the likely cause of the spike was neither optimism about growth nor fears of inflation. Rather, it was caused by a surplus of bond auctions hitting the market all at once.

The U.S. and European governments have continuously flooded the market with more debt, maybe this is a sign that it will lead to instability.

Figure 1 – 10-year Treasury Yield (TNX)

Financial stocks benefited from the Tuesday’s yield spike. Meanwhile, you might have expected that same spike to cause a selloff in tech stocks. That didn’t happen.

John and Wade suggest this divergence is evidence of traders being uncertain about today’s market.

Here’s their take:

Although the market action on Tuesday was noteworthy, it wasn’t dramatic enough to change our view.

It’s merely a signal that traders are split, and that will probably lead to more erratic price movement than we have seen in August and September so far.

***Volatility also got a boost from a stronger dollar

Below, we look at the U.S. Dollar Index.

It’s a measure of the value of the U.S. dollar relative to the value of a basket of six major global currencies – the Euro, Swiss Franc, Japanese Yen, Canadian dollar, British pound, and Swedish Krona.

I’ve circled in red the spike that’s happened since last Friday. Though it’s pulling back today, it’s been soaring over the last handful of trading sessions.

Source: StockCharts.com

Here’s John and Wade explaining why a dollar spike would rattle the stock market:

Unfortunately, if the dollar gains against other currencies, it can put U.S. exporters at risk and it lowers commodity margins for oil and metals producers.

In short, it’s about earnings. If the dollar gets too strong, it hurts the bottom lines of multinationals. So, a spike of this magnitude in just one week rattles some nerves.

But let’s return to the Strategic Trader update for a broader viewpoint:

To put things in perspective, the dollar is still within its normal long-term range, and a stronger dollar helps keep a lid on inflation, but it is worth watching.

***Finally, risk assets are running into headwinds

John and Wade write that the most critical short-term issue causing angst among traders has to do with risk assets – specifically, bitcoin and its relationship to small-cap stocks.

On Tuesday, bitcoin and the entire crypto sector suffered a flash crash. The crypto sector is down again today as I write. This has impacted traders’ appetite for more volatile stocks, such as small-caps.

Here are John and Wade explaining:

As the cryptocurrency market has grown, it has established itself as a pretty good barometer for the willingness of traders to take on new risks in the short term.

In other words, if bitcoin is doing well, traders are likely willing to deploy capital in other risky areas like small-cap stocks.

Unfortunately, the currency tanked on Tuesday after El Salvador’s plans to roll out the currency as legal tender fell on its face. Bitcoin was down by more than 18% at one point on Friday as El Salvador’s “digital wallet” technology struggled with technical issues.

The reason bitcoin’s crash is relevant for stock traders is that risky stock classes, like small caps, are bumping up against resistance right now…

If bitcoin’s drop affects sentiment, then resistance at this level will likely hold.

Putting it all together, are stocks at an inflection point, or will the upward march resume?

Here’s John and Wade’s bottom-line:

We feel that volatility in risky assets like bitcoin and small caps, or a small move higher in long-term interest rates are transitory issues and will not affect the market negatively in the long term…

Market fundamentals still look great.

If small caps retrace, we should get more opportunities to enter more bullish positions at support. A short-term retracement in the major indexes should work out well for us.

So, let’s keep our eye on the 10-Year Treasury yield and the strength of dollar. But for now, there’s nothing too alarming signifying a change in market strategy.

***A deeper dive into the crypto flash crash

Before we wrap up today, let’s look at what happened earlier this week in the crypto market.

As you’re likely aware, Bitcoin plunged from $52,000 to $43,000 in a matter of hours, taking the whole crypto market lower with it.

For more color on this, let’s turn to our crypto specialist, Luke Lango, who’s behind Ultimate Crypto with fellow crypto expert, Charlie Shrem:

El Salvador announced months ago that it was going to make Bitcoin legal tender. The law in El Salvador was set to go into effect at 5 p.m. Eastern on Tuesday. That is something that had been known for weeks…

Ahead of that official law signing, a large Brazilian Reddit community with more than 3 million users hatched a plan to get all its users to buy $30 in Bitcoin. That spread to other Reddit forums, and by Monday evening, Reddit forums across the globe were coordinating a mass retail move to buy Bitcoin before the El Salvador law signing.

Of course, crypto whales got a hold of that news, and figured they should sell ahead of the event – on the idea that they could dump their holdings for a huge profit on retail investors, and then buy back those holdings at much lower prices after those inexperienced retail traders freaked out and started panic selling.

Their plan worked out perfectly.

Luke explains how the bitcoin whales began selling on Tuesday. That tripped some sell alerts from various computerized trading programs, prompting additional selling.

The downward price spiral panicked retail investors who weren’t prepared for volatility. They raced for the exits as bitcoin fell by about $10,000 per token within minutes.

The whales were then happy to swoop back in, buying bitcoin at discounted prices.

Back to Luke:

In other words, the Tuesday flash crash was just the “big boys” playing games with the retail trader and making a quick buck where they could. They did that, and now it’s over.

Now, it’s time to turn our attention back to the fundamentals.

In his update, Luke then walked through a handful of bullish stories, all catalysts for more growth in the crypto/blockchain sector.

By the way, next Wednesday at 7 PM ET, Luke and Charlie will be sitting down to hold a special, live event that dives into the crypto world.

I’ll bring you more details in the Digest in coming days, but in short, Luke and Charlie believe a new massive crypto bull market is forming, and certain cryptos could go parabolic.

If you’re curious about the steep gains that have been piling up in recent weeks with select altcoins, this is a must-attend event. Click here to sign up.

Have a good evening,

Jeff Remsburg