The S&P500 tumbled almost 4% last week. This was the biggest drop in a year. Volume surged, adding validity to the downward price movement. And volatility soared, also suggesting that the price drop was not some meaningless quirk.
The economic data points weren’t just bad; they were scary. New home sales slipped, when it was expected to grow. Durable goods orders dropped, instead of rising as predicted. While initial jobless claims were reported at just under 400K, they will almost certainly be revised higher. Chicago PMI fell, instead of holding steady. Consumer sentiment also fell, this time to its lowest level since March 2009. And last week’s stunner was the GDP report. Not only did the Q2 results come in much lower than expected (1.3% vs. 1.9%), but the Q1 results were slashed down to a negligible 0.4%, down from 1.9%. What’s worse, the GDP was also revised down for the last three years, so that the US economic activity today is still LOWER than it was back at the prior peak in late 2007! And the government claims that we’ve been recovering for two years now?
Technically, the daily charts are broken, once again. Not only was the 50 day moving average decisively crossed, but the S&P is now threatening the 200 day. If the 50 day continues to dip and cross under the 200 (it’s getting very close!), then look for an additional 5% – 10% drop to quickly follow. But in the very short-term (one to two weeks), the S&P has fallen so hard that it’s actually somewhat oversold. And a bounce next week would not be out of the question. On the weekly charts, the topping formation that began in March earlier this year is still expressing itself. What’s also very clear on the weeklies is that there’s a lot of empty “air” beneath today’s prices. In other words, should another meaningful drop occur over the next month or two, there’s very little obvious support to dampen the fall.
So what sparked last week’s big sell-off? The near-term catalyst was the US debt ceiling impasse. It suddenly became clear to the markets that they can’t take for granted that Congress will raise the government debt limit as it has routinely done in the past.
Is this—by itself—a serious problem? Not even close. In effect, it’s a political charade where the two parties are playing a game of chicken. And if the ceiling isn’t lifted by August 2, then another 4%-5% drop in the S&P will almost surely end the political games and the ceiling will be lifted.
Does this mean that the markets can relax and resume rallying because some serious problem has been solved. Yes and no. Yes, the markets will most likely rally for a bit. But no, the root problem (massive over-indebtedness in all sectors—corporate, household and government) will not be solved. The can will merely get kicked down the road….for a short while.
What are the other catalysts that can rock the equity, and other risk, markets?
Sadly, the list is growing.
Near the top of the list is Europe. And no, it’s not Greece again. It’s not even Ireland or Portugal (although all three are still ticking time bombs). Now it’s suddenly Spain and Italy, whose government bond yields have exploded over the last several weeks. The problem is that Italy and Spain—each—have more debt that the other three PIIGS combined. Italy and Spain, arguably, could be too big to save for the EU, the ECB and the IMF. So if Italy and Spain keep falling, then look for an ugly reaction in risk assets globally.
Also on the list is China’s slowing economy. Recent purchasing managers’ index reports are showing a huge slowdown in orders and general economic activity. The Chinese stock market is near its lows for the year. If the US economy keeps tanking, then China’s economy will tank with it.
Linked to China are Canada, Australia and Brazil (for their raw material exports). All three are showing signs of weakening. Canada, for example, just reported a drop in GDP, its largest decline in two years. Australia is suffering from a real estate bubble breakdown, one that is just getting started. Brazil is suffering from an explosion in inflation. If these three feeder economies start slipping, then there will be negative blow back to the rest of the world.
Finally, Japan is still struggling to recover from its earthquake, tsunami and nuclear disasters from earlier this year. If the rest of the world continues to slow down, then Japan’s exports will get slammed, most likely shoving Japan’s fragile economy back into recession…..at a time when its government debt load is exploding and its current government (Kan) is teetering.
And there’s more. Again, these are just the most prominent economic risks that are known. There are many geo-political risks that are simmering and of course, there’s always the unknown unknown that can strike out of nowhere.
What makes all this all the more serious is the fact that economic stability in the world is very shaky today. So it wouldn’t take much “stress” to stunt economic activity and trigger a meltdown in global markets.
Let’s hope it doesn’t happen, but it’s best to be prepared in case it does.