The S&P500 bounced back up 3.5% last week. Volume was light, so this price move was not confirmed by the retail investor jumping back in with conviction. In fact, the average retail investor pulled money OUT of the stock market again–14 weeks in a row, according to ICI which tracks mutual fund flows on a weekly basis.
There was very little economic data this week, but most of it was disappointing. The housing market index of builders registered the lowest reading since the summer of 2009, near the all time lows. Housing starts for June fell about 5%, and the prior month (May) was revised lower. The housing market is clearly set to collapse again. And there is very little that the government can now do to prevent this impending plunge. Initial jobless claims were higher than expected. And although the US government reinstated the full 99 week unemployment claims program, there are thousands–soon to be millions–of people who will drop off this program after the full 99 weeks are used up. At that point, if they’re still unemployed, they face the dismal prospect of applying for welfare relief.
Technically, the S&P did puncture the first line of resistance–the 50 day moving average. Next week, we will see if the next line of defence, the 200 day moving average, will hold. If the S&P breaks through 1,110 and closes there for a few days, technicians will watch the 1,160 to 1,170 level to see if such a move upward will build the giant right shoulder of the head and shoulders pattern that began with the left shoulder (near these same levels) in January of 2010. On the weekly charts, the S&P is still in the downward sloping channel that began to form in April.
The Economic Cycle Research Institute’s weekly leading indicator index broke below -10 to log a reading of -10.5 last week. In 42 years of record keeping for this index, the US economy has always entered into a recession (new or double dip; it doesn’t matter) when the weekly leading indicator broke below the fateful -10 mark.
So unless “this time is different”, the odds are nearly 100% that the US economy is headed for a contraction sometime over the next three to six months.
This coincides nicely with the long-term technical turn downward in the S&P500. If, as now expected, the economy enters a recession this fall, the S&P500 will have anticipated this slowdown by about six months.
And since the housing market was one of the main drivers of the downturn two years ago, it’s no surprise that the renewed drop in the housing market this year will also help push the economy down this time around.
So what’s an investor to do?
Well the S&P500 and many other risk asset markets have NOT yet fully priced in the effects of a true recession. Ominously–just as in the prior downturn–the only market that seems to be prepared is the US Treasury market; it’s massive plunge in yields is suggesting that the risk asset market price drops will be severe.
So the smart money is busy preparing a buy list. If, or when, this “risk off” phase begins, the astute investor will be prepared for the big, clearance sale. The main question that remains to be answered is if it will be a 20% off sale, a 30% off sale, or a 50% off sale.
By preparing the shopping list now, the smart investor will not be frozen like a deer in headlights when the sell-off panic sets in. The dumb money will be desperately trying to sell. Make sure you think through–in advance–what you want to buy and at what price.
Christmas might arrive early this year.