The Real Selling Has Not Started…Yet

After a rollercoaster-like ride, the S&P500 finished the week essentially unchanged.  Volume was heavy.  The VIX (or fear) index fell off, but still closed the week at an elevated level that suggests that traders and investors are worried.

Last week’s economic data were not strong–further implying that the consensus V-shaped rebound in the US economy is not only failing to materialize, but also that there is now a growing chance that the economy will slip back into recession. 

Existing and new home sales were higher than expected, but only because of the government tax credit, which has now expired.  More ominous for the housing industry, inventories of existing homes soared; this will now put even more downward pressure on home prices going forward.  Durable goods orders were stronger than forecast, but without transportation orders, they were weaker than anticipated.  Inital jobless claims were worse than expected.  Q1 GDP was revised down to 3.0%; economists had expected it to be revised up to 3.5%.  Personal spending came in flat; it was expected to rise 0.2%.  Personal income also disappointed.  Chicago PMI was loser than forecast, but consumer sentiment was better.

The technical story for the S&P is very interesting now.  Since the beginning of May, the charts–on a daily basis–have drawn out a bearish cascading pattern.  Not only are prices pointing downward, they look like they are falling off a cliff. 

And the spiking VIX together with the surging volume only add validity to the price drops.

But counterintuitively, prices are likely due to bounce back for a while–at least to their 200 day moving average, and even to their 50 day moving average.  This means that the S&P can crawl back up to 1100 and even to about 1150 without breaking the newly established downtrend.

How long will this rebound take?  It can easily consume much of June, which begins next week. 

But then–later this summer and into the fall–the real fun begins.  These 50 day and 200 day moving averages will now act as a ceiling, or resistance, to price rises.  If and when the S&P moves toward them, new selling will likely kick in and push prices back down away from these critical levels.

And once the rebound runs out of steam, the move back down will slow when it reaches about 1,050 on the S&P–the lows hit in May.  If these lows are broken, then the next move down will likely break 1,000.

All of these down drafts can be accelerated if more unanticipated bad news breaks in Euroland or anywhere else in the world.  And given how overbought equity prices were over the last three months, the rush to sell could be dramatic.

Owners of equities, seeking to preserve recent gains, and speculators seeking to benefit from a sell-off by shorting, will rush to sell.  This rush could turn into a stampede, reminiscent of the May 6 flash crash.

The difference this time?  It’s very possible that prices will not snap back.  They could plunge–in a day or two–and stay there. 

Technical analysis is sounding an alarm.  Be prepared.

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