Why The Sell-off Was Overreaction

Why The Sell-off Was Overreaction

Risk off isthe name of the trade today. Investors are tensed due to the fear of a prolonged economic slowdown due to the outbreak ofCoronavirus was anticipated. In reality, it was nothing more than the marketparticipants overreacting to news of the virus spreading.  This slowdown was indeed expected, and Ifinvestors thought that the virus wasn’t going to spread or wasn’t going tocause some minor shocks to the global economic growth, then yesterday certainlywas an awakening call for them.

Overall, I do not see any significantreason as to why the Dow Jones should plunge over 1000 points, as there isnothing new about the on-going virus. The fact is, that the way investors wereacting yesterday made the situation look like a pandemic.

The Dow Jones plunged over 1,000 points ornearly 3.56%, the S&P500 fell 3.3.5% and the NASDAQ index took the losingcrown, it dropped nearly 3.71%.

So, the question remains, should investorsconsider the current sell-off as an opportunity?

Well, before we answer this question, it isimperative to look at the price action of the risk-off instruments such as thevolatility index and gold. The VIX index jumped over 46% yesterday and itcrossed above the 25 mark for the first time since April 2019. The Europeanequity volatility also surged yesterday; the Euro Stoxx 50 volatility indexadded as much as 47%.

The fact is, nothing significant occurredyesterday which caused both of these indices to surge the way that they did. Inreality, the actual fear number for the VIX index starts after the 35 mark. We have seen the VIX index surging to level of 25 (approx.) back inAugust last year but after that, the price retraced. The actual spikes thattook the price out of the 35 mark, happened in December and February 2018.Those were the kind of spikes which shook investors’ confidence. The belowchart shows these points

As for the gold price, we didn’t see muchstrength in the price action. In fact, on a daily time frame, we can see thecandle chart forming a bearish candle, meaning the momentum wasn’t there at alland the closing price was very close to the opening price. Gold price surgedtoo fast—not a good sign. Hence, today we are not seeing any upward move. Ithink it is likely for the gold price to retrace a little or consolidate beforethe upward momentum takes off again.

The bottom line is that yesterday’s sell-off was nothing more than market participants overreacting. To answer the above question, if the S&P500 index crosses back above the 50-day moving average on a daily time frame, then this could be the opportunity that investors have been waiting for. However, if the price fails to cross above the 50-day SMA, then it is likely for the price to touch the 100-day SMA.