Morning Comment: The spill-over of a key de-risking policy.

Much like the coronavirus in January and February of 2020, the situation facing Evergrande has been staring investors in the face for a while now…and yet they have ignored the growing negative situation (mostly due to the fact that the vast majority of Wall Street told them it was nothing to worry about). The problem with issues like these is that they don’t matter…until they do.

The HUGE decline in Evergrande’s stock and bonds that we have been focusing on for many weeks has now spread to other real estate giants in China. (One smaller developer…Sinic Holdings…had its trading halted after it fell 87%!) It is also weighing on insurance stocks and bank stocks in that part of the world, so investors are now finally starting to worry about a contagion. Of course, “contagions” are not all the same. However, the one component of the of the Evergrande disaster that has unfolded over many months that we’ve been focused on is finally come to a head: Investors have finally become worried about liquidity issues. In other words, there seems to be a spread of margin calls and “forced selling.”

It’s amazing to us that people could think that the leader of the world’s second largest economy could embark on a major de-risking/de-leveraging program…without it spilling over into other markets around the globe. Back at the beginning of 2020 (in January & early February), we kept telling investors that the consensus on Wall Street was wrong…and that the pandemic would become a major problem. Therefore, we said, investors should raise some cash and add some hedges…..Recently, we have been the exact same thing. We have simply believed that the overbought, overvalued and over-leveraged U.S. stock market could not avoid being impacted by the de-risking of such an important economy as China’s.

No, the moves we’re seeing in the U.S. futures this morning do not necessarily mean that the kind of deep correction we’ve been calling for has definitely begun. We’ve had several days this year where futures were trading much lower in pre-market trading…only to have the market bounce-back that day…or at least within a couple of days. This might take place again this week. However, given how much the Evergrande debacle is starting to spread, it’s going to be very difficult for the stock market to bounce-back as quickly as it has at other times this year.

There is little question that the 50-DMA will be broken this morning. We do need to point out, however, that the S&P fell 2.5% below its 50-DMA back…in the middle of the day…on one trading day back in March. However, it was able to regain that line by the close of the following day. Therefore, if the market CAN recover very quickly…like it has so many times this year…the impact of the Evergrande might be pushed-out for a little while. However, if the S&P falls further…and does not bounce-back very quickly, it’s going to be a major warning flag for the stock market.

However, as we pointed out in our weekend piece this past weekend, the next support level is not very far below the 50-DMA. The 100-DMA provided nice support for the S&P 500 back in both September and October of last year. Therefore, it might be able to slow any slide before things start to get ugly. Having said this, a break of that 100-DMA would confirm the break-down in the stock market…and it would signal that a test of the 200-DMA (down at 4,100) is all but certain.

Our biggest concern…and the reason we’re calling for a deep correction and not just a run-of-the-mill 10% correction…is that there is a record level of leverage in the system (with margin debt about 60% above 2007 levels). Therefore, once the market falls about 10% or so, we’ll start to see “margin calls” hit the street. That, in turn, will cause some “forced selling”…and cause the situation to snowball.

Of course, things won’t playout exactly as we have described it this morning. Like we said, the impact of China’s pronounced de-risking/de-leveraging program might not impact the U.S. and other global markets quite yet. In our opinion, it’s only a matter of time. However, given what we’ve seen lately…with the narrowing of the rally…we think it is VERY likely that this IS the beginning of a deep correction. It won’t come in a straight line, but it sure looks to us like it is dead ahead. Watch that 100-DMA. With the 50 DMA already broken, a drop below that moving average should give us the confirmation we need.

Matthew J. Maley

Chief Market Strategist

Miller Tabak + Co., LLC

Founder, The Maley Report

275 Grove St. Suite 2-400

Newton, MA 02466


Although the information contained in this report (not including disclosures contained herein) has been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. This report is for informational purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security. Any recommendation contained in this report may not be appropriate for all investors. Trading options is not suitable for all investors and may involve risk of loss. Additional information is available upon request or by contacting us at Miller Tabak + Co., LLC, 200 Park Ave. Suite 1700, New York, NY 10166.

Posted to The Maley Report on Sep 20, 2021 — 8:09 AM
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