The Tell: 4 signs a stock-market selloff in February may be brewing

U.S. stocks on Monday descended significantly for the first time in the Donald Trump postelection era that delivered a multimonth shot in the arm to equity investors.

There are signs that stocks, which have risen on hope that the new president would unfurl a slate of policies favorable to Wall Street, may see a healthy downturn from recent records.

On Monday, the Dow Jones Industrial Average DJIA, -0.54% S&P 500 index SPX, -0.09% and Nasdaq Composite Index COMP, +0.02% all registered their worst daily drops in weeks and Monday’s decline could be a harbinger of more weakness ahead, according to Jonathan Krinsky, chief market technician at MKM Partners. On Tuesday, the S&P 500 and the Dow renewed their drive into negative territory, settling lower.

Doubts about Trump’s legislative focus and policies, which have tended to garner more jeers than cheers, are starting to significantly erode momentum from a record-setting climb. The major indexes had been hovering around all-time highs as recently as Thursday, highlighted by a push to the psychologically significant level of 20,000 for the blue-chip gauge.

Krinsky, however, makes the case that Monday’s action may not be an aberration. He points to a few technical factors that support the notion of a downturn that could see the S&P 500 index shed about 5% of its value, bringing it to a range of about 2,180 to 2,190, marking the broad-market gauge’s lowest levels since around November.

Seasonality

Most notably, February tends to be a seasonally weak month for stocks over the past four decades. That trend is magnified in postelection periods, with the S&P falling 1.85% on average in the years following a presidential election, Krinsky said in a note dated Sunday (see chart below):

Days without a 1% pullback

There have been 75 sessions (including Monday) without a 1% drop in the S&P, which marks the longest such streak in about 11 years, according to Krinsky. A period of sideways trading tends to suggest that the market has pent up momentum. And if history is any gauge, momentum may be leaning toward a downturn, given the market’s tendencies in February.

Fear is a factor again

A measure of Wall Street fear has been hovering around its lowest levels since about 2014, but then on Monday it had its biggest percentage jump in three months.

Readings for the CBOE Volatility Index VIX, +0.93% of around 12 tend to imply complacency in the market, while those of 20 indicate that the market is betting on a swing in prices to occur sooner than later. Monday’s sharp move pushed the “fear” gauge to 11.88—still very low by historical standards.

Bearish bets

MarketWatch’s Joseph Adinolfi reported in mid-January that options bets that the market would tumble in February were on the rise. Those bets imply that many investors are bracing for a big selloff in February.

Rising political uncertainty also has been increasingly cited as one of the biggest concerns for markets and that may be hard to price in the era of Trump.

All that said, Krinsky still sees a downturn as a buying opportunity for investors. So, he’s expecting that any sizable retreat will be met with a rally that could take the market higher before these 2017 gyrations end.

Investor takeaway: To be sure, the equity market could power through February with nary a blip lower, especially given all the “animal spirits” that have been at work in markets lately. Moreover, stocks have climbed since the Nov. 8 election. Even with Monday’s pullback, the Dow has gained 8.9% since Election Day, the S&P 500 has risen 6.6%, and the Nasdaq Composite has climbed 8.1%.

Still, it can be worth knowing how some market participants are positioning themselves.

This story was first published on Jan. 30, 2017.

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