Waiting for the Avalanche

The S&P500 eked out a tiny 0.46% gain for the week.  Volume was the lowest of the year, so far.  The low volume removes all conviction behind the small price gain.  And the VIX (or fear) index rose about 3%, also calling into question the importance of the price rise.   

There wasn’t a lot of macro data in this holiday shortened (Labor Day) week.  The Fed released its most recent beige book of economic conditions around the country.  The most notable quote from the report was that there are now “widespread signs of deceleration” in economic activity.  Consumer credit fell again, by slightly more than expected.  International trade data showed that the US imported almost $43 billion more than it exported.  Although an improvement over the prior month’s $50 billion figure, the bottom line is that the US trade deficit is stubbornly high and still hurting GDP growth.  Initial jobless claims appeared to improve with a 451,000 print, but it was soon revealed that claims for nine states (including California) were estimated due to the Labor Day holiday.  Chances are very high, the actual claims were worse than estimated. 

Technically,  the bounce that began two weeks ago is losing some steam.  Although there is still some room for more upside movement, the 200 day moving average will provide stiff resistance as it did at the end of July.  This suggests that prices could rise up to 1,120 to 1,130 before they begin to struggle to rise further.  On the weekly charts, prices are at the upper end of the downward sloping channel that began in April.   The downtrend has not been broken, and a strong catalyst will be needed to propel prices up much further.

The S&P at the end of August (1,040) was near the same level that was reached at the end of July last year.  So essentially, the S&P has gone nowhere in over a year.  And now, dozens of new economic reports are calling into question the entire recovery story that was sold to the public over the past year.  Monetary and fiscal policy do not seem to be working.  Unemployment (the official headline number) is 9.6%, near the highest levels in 70 years.  And it’s climbing.   The Fed has shot most of its bullets:  the fed funds rate is near zero and it has printed over $1.5 trillion in additional dollars to pump into the economy.  The Treasury and Congress have pumped about a trillion dollars into the economy, and there is no public support for enacting another stimulus program.

So as economic growth slides back down to zero, and unemployment hovers near record highs, the stock market’s jump from the 600 range to 1,040–in anticipation of the economic recovery–becomes extremely vulnerable to a strong and prolonged correction. 

So why hasn’t it occurred yet?   Well, some of it has.  The S&P is well off its highs near 1,220 reached in late April.  The question becomes, if the economic recovery is not going to be V-shaped, bringing the US back to where it was back in early 2007 (the prior peak in GDP growth and employment), then when—exactly—will the stock market crack and let go of the false hope implicit in its current 1,100 valuation?

The answer is:  who knows.  And a fitting metaphor might the forces and timing involved in setting off an avalanche.  When snow piles up on an unstable (steep surface) foundation, experience teaches us that the risks of a catastrophic avalanche grow.  But the price time when the avalanche is triggered is never knowable.  And the exact trigger is also usually unknowable. 

But, that doesn’t mean that the risk of a tragic outcome is not real, or that it won’t happen.  The Flash Crash gave us a taste of what an avalanche in the stock markets feels like.  And today, four months later, the underlying conditions that led to the crash have not changed.  Instead, more snow has been piling up; more stress has been building. 

Sooner or later, the equity markets will crack—again.  It’s not a question of if.  It’s a question of when.

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