Falling Knife

Traders and analysts would call the sharp drop in stocks we’ve seen this week a “falling knife.” Use of this phrase is often accompanied by a warning not to try catching such knives by buying in the midst of a plunge. The question then becomes, when would be a good time to buy? While there’s no best answer to this question, many traders will wait for signs of a potential rebound and recovery. So far, we haven’t seen much of a clear sign.

Friday’s continued tumble for global equity markets was driven by President Trump’s Thursday tweets that a 10% tariff will be added on $300 billion dollars of goods coming from China to the U.S., beginning Sept. 1. Although Trump later softened the tone by saying he would not implement those tariffs if China increased its purchases of U.S. agricultural products, the damage had been done. As might be expected, China shot back on Friday morning saying in no uncertain terms that it would have to retaliate if the additional tariffs are implemented.

This heavy pressure on stocks comes on the heels of a Fed interest rate announcement earlier in the week that was less dovish (and less supportive of the stock market overall) than investors had hoped. This helped bring stocks down sharply from new record highs.

The U.S. jobs report for July was released on Friday, and the results were about as expected. But this data hardly registered on investors’ radars amid concerns over trade, the global economy, and the Fed.

The S&P 500 (SPX) chart shows the damage done by the slide in stocks this week, which was the worst week for the index so far this year. On Friday, the index sliced through its 50-day moving average to the downside. It also fell sharply below the previous support level around 2,960. While the S&P 500 is still trading in a sharply bullish trend, the bottom border of the trend channel is currently around the 2,900 level. If that level holds, we could be seeing a recovery of the underlying uptrend.

Although the Fed was seen as less than dovish when it announced its interest rate decision this past Wednesday, bond yields subsequently fell sharply due to fears that an escalated U.S.-China trade war would weigh heavily on the global and U.S. economies. In turn, pressure on economic growth would compel the Fed to cut interest rates more aggressively.

As shown on the chart, the 10-year U.S. Treasury yield fell well below 2.000% on Thursday and Friday, ultimately hitting an extreme low not seen since November 2016. Needless to say, rates are currently very low, but they could continue even lower toward 2016 lows if fears of a global slowdown or recession intensify further. 

Finally, gold hit yet a new six-year high on Friday, boosted by a double whammy of increased global risk concerns and expectations of lower interest rates from the Fed in reaction to trade-related economic pressures. We discussed gold early this past week when price was still consolidating in a rough pennant pattern, which is usually considered a trend continuation formation. Now, the price of gold has tentatively broken out of that pattern, which hints at a potential extension to the upside. If trade and economic concerns resume in the week ahead, which is likely, gold may be poised to reach for higher highs.

While it may seem that the sky is falling right now, it most likely isn’t. Trump’s tweets and pronouncements have long roiled markets, but it would likely take much more than tweets about tariffs to do any major, lasting damage to the markets. There’s been much speculation that the threat of tariffs may be yet another ploy, this time both to pressure China into striking a deal more favorable to the U.S. and also to compel the Fed to take on a more aggressive rate-cutting stance. In any case, while it may not be a good idea to try catching falling knives, investors should be alert to opportunities once downside momentum has been exhausted.

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