After the technical breakdown of the charts was noted a week ago, the S&P500 did fall again–as predicted. The index finished the week down almost 2 percent. Volume surged, which lends more validity to the price drop. Also, the VIX index spiked over 20%, which is also a signal that helps confirm the price downward move.
The US economy continues to struggle. Housing starts are once again collapsing (on a month to month basis), but from already depressed levels. Permits were also dismally low, falling to the lowest level ever recorded. Both starts and permits are substantially lower than they were a year ago. Producer prices wer higher than expected; this will increase corporate costs, which will hurt corporate profits. Consumer prices were also higher than expected; this will make it harder for consumers to buy more products and services, which will hurt corporate profits. Initial jobless claims met expectations near the recessionary rate of 400,000. Industrial production badly missed; it fell, when it was expected to rise. Leading indicators also badly missed, but the Philly Fed survey beat expectations.
Over the last year or so, this blog has counted numerous ways in which the Fed-engineered stock market rally (now, arguably, a bubble) could be reversed, leading the market into a severe correction and resumption of the secular bear market that began after the 2000 tech bubble burst.
While the Fed, primarily through its money-printing QE programs, has been doing an admirable job of propelling stock prices upward, the argument has been made that the fundamental economic problems (that are behind the secular bear market) have not been fixed. And until they are fixed, a true secular bull market cannot begin.
The single most important problem is the total credit market debt to GDP ratio in the US (and in most of the world, for that matter). Sadly, this debt load is still sitting near all-time high levels, with the US government–lately– taking on the greatest share of this total debt load (relative to GDP).
So the challenge has been to look for triggers that could overcome the Fed’s powerful monetary BandAid policies (they’re BandAids because they cover up the over-indebtedness without doing anything to lower it; ie. actually fix the problem).
This list of triggers has included global sovereign debt crises, currency crises, trade crises, US state fiscal crises, Chinese bubble risk, and geo-political crises. But the key takeaway was that the one trigger event that would actually cause markets to sell off would most likely not be on this list; in other words, it would be an unknown risk.
And sure enough, last week’s sell off was triggered by a massive earthquake in Japan, an earthquake that led to a disastrous tsunami and a still ongoing nuclear meltdown crisis.
But most importantly, for the stock markets, this is only a scratch. It is not–yet–a sure thing that the secular bear market has resumed. For that to happen, a cyclical bear market must first get established. And we are still far away from the 20% sell-off (from the February 18 peak) that would ring the bell announcing the arrival of a bear market.
So what’s next?
The uptrend line, broken two weeks ago, is still broken. And the stock markets are even slightly oversold, so that a bounce would not be surprising. After this bounce (and even if no strong bounce emerges), the S&P must resume its decline for the newly established downtrend to remain intact.
This will be a challenge, primarily because the Fed’s QE2 program will continue for another two months or so. But the Fed, last week, confirmed that it WILL be ending this QE program cold turkey in a couple of months, as originally planned.
So if this downtrend does not hold over the next 30 days, it’s highly likely that it will re-establish itself as equity investors head for the exits in advance of the end of QE2. They will certainly not wait until it actually ends to leave the stock market party. Because the last ones to leave, may not be able to get out without getting crushed.
So continue to enjoy the party, even if it manages to keep going over the next week or two. But start putting your jackets on, locate your car keys, and head closer to the exit doors. Because when the punchbowl finally runs out, you don’t want to be the last person standing on the dance floor.