Not a good sign. While the S&P500 slipped only a quarter of a percent last week, it was sorely overdue for a relief rally, and yet it failed to get one. Volume jumped, but only on the sell-off days—another bad sign. Although volatility dipped slightly, it was roaring back up by the end of the week. Also not a good sign.
In terms of macro data, the news flow was light. Existing home sales fell (month over month) but not as badly as expected. Still, sales were down 15.3% year-over-year, and prices were down almost 5% (also yoy). Initial jobless claims again disappointed, printing a figure (429,000) that’s solidly in the recession zone. New home sales were a bit higher than expected, but still near depression levels when compared to the last ten years. Durable goods orders were also a bit better than expected, but when aircraft orders were stripped out, the results were worse than expected.
Technically, the S&P is still very oversold in the short-term. While a bounce has been expected for the last two weeks, the fact that it hasn’t happened is an ominous sign—equity markets are struggling to lure in the dip buyers, the same dip buyers who have been helping (the Fed has been the greatest driver) push the markets higher for the last couple of years. We could still see a bounce next week, or the week after. But if it doesn’t happen by then, then watch out. The S&P is now sitting just a little above its 200 day moving average. If it doesn’t bounce and starts breaking down below the 200dma, then there may not be a lot of buyers willing to jump in until prices fall well below 1,200.
The Fed’s quantitative easing program, which has had a 90% correlation with the stock market rally since September 2010, will be ending next week. As a reminder, last year’s QE1 program ended on March 31 2010. A couple of weeks later, the S&P500 hit a new high for the year. Then near the end of April, the S&P started breaking down. A week later, in early May, we saw the Flash Crash. And a couple of months later, the S&P was down almost 20%.
Arresting this budding bear market was the Fed. First it announced QE-lite in mid summer, which slowed the bleeding, but didn’t stop it. Then, at the end of August, Bernanke pre-announced QE2 and stocks have been rallying ever since.
Well not only will QE2 end in a few short days, but the Fed has just reminded all market participants, that QE2 will NOT be followed by QE3 anytime soon. And this, shockingly, took the wind out of the stock market’s sails. It seems that the main reason stocks had not anticipated the end of QE2 by selling off hard by now was the strong hope that the Fed would save the day once again. The markets have been conditioned to expect the Fed to ALWAYS provide a tailwind.
But last week these hopes were dashed. Suddenly, risk market participants are digesting the fact that the Fed will really pull away the punch bowl for a while. And without the massive stimulus, the party will no longer be so fun anymore.
In fact, things could get downright ugly. So the smartest money is making preparations, taking money off the table and battening down the hatches.
What will a risk-off period look like, more specifically?
Aside from a continued erosion in stock prices (hardest hit will be the smaller caps in the Russell 2000, followed by the NASDAQ, and least damaged should be the S&P), look for declines in:
- Commodities, including precious metals
- High yield corporate debt
- The Euro, the Australian dollar, the Canadian dollar, and the British Pound
What, if anything, would RISE in price?
- The US dollar
- US Treasuries, although they’ve may have less room to rise given that they’ve move up so much already.
Again, this may not happen next week or the week after, when a bounce up in risk assets would be very normal to see.
But if the bounce doesn’t happen, and even if it does, we should expect the odds of a serious decline in risk assets to jump…..in the near future.