Calm Before the Storm?

The S&P500 dropped almost 2% last week.  And this drop makes it four weeks in a row, the longest weekly stretch of losses since February.  Volatility (VIX) crept up for the second consecutive week, the longest weekly stretch of rises since January.

Last week was a quiet one for economic data.  Consumer credit continued dropping–not surprisingly as people (consumers) keep losing jobs and fail to secure new ones.  Initial claims fell under 600,000 but that happened during a holiday shortened week (July 4) so it’s hard to conclude that unemployment claims are falling off sharply.  Continuing claims spiked however–to a record 6.88 million.  The trade balance improved, but another takeaway is that trade for the U.S. (and the rest of the world) is shrinking–hardly a positive sign.  Michigan sentiment fell, when a small rise was expected; this surprised many analysts who argue that our consumer led economy is on the mend.

Technically, all time frames are pointing down.  The daily charts suggest that a major support level around 880 has been violated.  Since the middle of June, after peaking at 956, the S&P500 has initiated a weak downtrend.  The weekly charts also point to a breakdown and weakening of the uptrend that began in mid-March.  On the long-term monthlies, the predominant downtrend is still firmly in effect.

The green shoots rally is beginning to fade.   All of the price jump from March 9 to June 11 rested on a multiple expansion, not the growth in earnings.  This means that at some point, the earnings must start to expand.  And the market seems to be implying that that point is imminent. 

What’s eerie is that the equity markets adopted a similar psychology about a year ago, with most analysts expecting a major rebound in corporate earnings in Q408.  We all know what happened.

Other similarities include a rising, and then suddenly falling commodities market.  Oil, for example, ran up strongly this year and peaked in June at about $75 per barrel.  Like last year, oil peaked in the summer and then started falling rapidly–it is now at $59 and falling. 

The Yen and the U.S. dollar are also rising as investors seem to be seeking out safe havens.  And the dollar’s rise is occurring despite the well publicized ballooning of the U.S. fiscal deficit.

And ominously, just like last year, financial stocks are selling off.  Citibank is melting back down into the $2 range.  Larger regional banks, like Regions, are almost back down to their March lows.  And commercial lenders such as CIT are nearing bankruptcy.

Equity market volumes are eroding on a daily basis–not what you’d expect in a true bull market.  And the VIX, which traditionally bottoms during July, is creeping back up after touching levels (25) last seen before the Lehman blowup.

Market risk appetite appears to be fading.  The stars seem to be lining up for a strong sell-off.  It’s not clear if this sell-off will start next week, or the week after.  But between now and the early fall, a lot of signs are pointing to another storm in the equity (and credit) markets.

It’s calm now, but dark clouds loom on the horizon.

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