The Omicron COVID–19 variant blindsided a very confident market last week.

This year’s Black Friday – now nicknamed “Red Friday” – was the biggest Thanksgiving market rout in the last 70 years.

News of a newly mutated COVID–19 virus has the market on edge again.

The new variant seems to be spreading fast, and unlike the Delta variant, Omicron has evolved many mutations that may help the virus make current vaccines obsolete. This all comes against a backdrop of new cases that were already pointing to another wave this coming winter.

In less than a few hours on Friday, the market erased all of its gains over the last month over virus fears.

We went from a state of peak euphoria to peak fear in one holiday shortened trading session.

But over the weekend, my colleague Jeff Clark showed how the downside was overdone… calling for at least a short-term bounce.

Sure enough, the market gapped up in a big way yesterday with the tech-heavy Nasdaq 100 up 2.6% at its peak.

But does that mean the downside is over? I’m not so sure…

The main reason the market bounced has to do with information released over the weekend easing investor concerns about the severity of the variant, even though it was very light on data points.

Of course, that’s great news, but the sample size was just a handful of relatively young and healthy patients.

Here’s an excerpt from Reuters:

Dr. Angelique Coetzee, a private practitioner and chair of the South African Medical Association, told Reuters that on November 18 she noticed seven patients at her clinic who had symptoms different from the dominant Delta variant, albeit “very mild”… Her experience so far has been that the variant is affecting people who are 40 or younger. Almost half of the patients with Omicron symptoms that she treated were not vaccinated.

Although seven cases doesn’t seem like enough data to make a judgement yet, the market opened over 1% higher on Monday.

Right now, it’s just too early to tell what the long-term effects on the market will be.

But as cases increase over the next couple of weeks, the information gap will close as more data comes in. That means we could be facing some wild swings in the markets… higher and lower depending on the tone of the news.

All of this presents a very interesting dynamic.

That’s because the market was bound to correct anyway – with or without the fear surrounding the Omicron variant. It was simply a catalyst.

For example, both Jeff and I have been bracing for a correction for weeks…

Here’s Jeff’s uncanny timing of his essay published just one day before the market fell:

Investors are relaxed and comfortable – maybe too comfortable… For the past month or so, we’ve been warning about the dangers of complacency. But, when stocks are running higher, no one wants to hear that sort of thing.

And here’s an excerpt from my essay two days before that talking about several divergences I was seeing in the market:

When I see sectors that typically lead markets higher (like financials) falling 3.5% – while the S&P 500 index keeps making new highs every day – I pause and start looking for opportunities to take money off the table and brace for a correction… Something has to give, and historically when divergences like this happen, it’s been the stock market that gets caught off guard…

It seems that the market is using the emergence of Omicron as justification for selling off. The implication is that if news turns positive on the spread and severity of the variant, the market will make even more new highs.

That could be the case…

But the divergences I mentioned earlier still haven’t fully played out, even with this recent dip in the market.

For instance, the VIX is trading at the same level it was in September, when the market was trading 5% lower. Typically, you would expect to see much lower levels in the VIX when the market rises as much as it has.

In addition, Friday’s selloff has created a very big level of resistance that the market has to clear.

Take a look at this chart…

The horizontal line marks 4660 on the S&P 500 and you can see how the index has been testing and retesting that level all month long.

Given the market rout on Friday, 4660 is now a major resistance area. It’s also where the S&P 500 opened on Friday, so a close above that level would be a big psychological boost for investors looking for new highs.

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Bulls would need to regain that area and close above it for the next leg higher in the market.

And yesterday’s bounce that Jeff was calling for got rejected right around that level…

Right now, investors should do two things…

First, update your watchlist to track “re-opening” stocks, sectors, and products that are more sensitive to COVID-related shutdowns. If they’re all flashing red and underperforming the broader market, it’s probably a sign of more market downside.

Think of the SPDR S&P Retail ETF (since a new wave would cut foot traffic), airline stocks (closed borders means less flights), oil prices (less flights mean less oil demand), and stocks like Live Nation Entertainment.

And second, watch that 4660 level on the S&P 500… because as long that level remains resistance, the market can have plenty more downside left.

Regards,

Eric Shamilov
Analyst, Market Minute

Reader Mailbag

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