For the fifth week in a row, the S&P500 fell, this time by another 4.7%. Volume was high, adding conviction to the price drop. Volatility, a measure of fear, surged by another 18%, rising to extremely high levels when compared to the prior three years. Tensions are rising, and from these levels, chances are high that the S&P will either bounce up strongly, or plunge far lower, perhaps even another 10% or 15% from here.
Last week’s macro scorecard was decidedly negative. The Empire State manufacturing survey fell hard, when it was expected to rise. Housing starts and permits were stuck at their near-depression levels. Existing home sales badly disappointed—despite the record low home mortgage interest rates. The single high note of the week was industrial production, which rose more than expected. Producer and consumer prices were—across the board—higher than expected; higher inflation will hurt households and corporations alike. Initial jobless claims jumped back up into the 400,000 range usually associated with recessions. Finally, there were two shockers last week: First, the Philly Fed survey literally collapsed. Instead of rising as predicted, it plunged to its lowest level since the depths of the recession in March 2009. Second, the US 10 year Treasury rate collapsed to under 2.0%, a rate not seen in about 60 years. Most economists agree that such a low rate is signalling the onset of a severe economic slowdown, if not a severe recession.
Technically, the S&P500 is broken. The damage done over the last few weeks far exceeds that of 2010. In fact, the signals on both the daily and weekly charts are now hinting that a new bear market is about to begin. Officially defined as a drop of 20% or more from peak, a bear market is now only 2% in losses (from the May high) away.
So what are the key events that could trigger further losses over the next few weeks?
Barring some unforeseen Black Swan event, two major events stand out.
First, is the Jackson Hole speech given by Ben Bernanke next Friday. Markets have been trained to expect gifts from Ben Bernanke when the going gets tough. Why? Because he, and his predecessor Alan Greenspan, have pretty much always delivered in the past when markets were faltering. So given this history, the stock markets have already priced in some sort of stimulus from Bernanke. Whether he pre-announces QE3 (as he did last year with QE2) or some variation of it, markets would take off if he hints that the Fed is prepared to super-size its balance sheet (ie. print billions of dollars more to pump into the markets). But, should Bernanke not announce this, chances are high that markets will tank. They will reprice by removing the anticipated stimulus and by pricing in a Fed that will be signalling that the “markets are on their own”.
Second, is the growing debt crisis in Europe. This crisis is now spreading quickly to major “too-big-to-fail” banks in France (eg. SocGen) and Italy (eg. Intesa) because of their diminished ability to fund themselves with short-term financing (often dollar-based, not euro-based), a problem that in part stems from their unrealized losses on their holdings of PIIGS sovereign debt. These financial institutions are “on fire” and if they blow up, their demise could be more devastating to the global financial order than was the bankruptcy of Lehman Brothers in 2008. Some experts argue that if banks such as SocGen were to fail, a global depression would be only the start of our problems. So the ECB—perhaps with secret back-door help from the Federal Reserve—will try to keep this fire contained. If it continues to spread, or heaven forbid, gets out of control, then the markets would not only drop, they would be at risk of collapse……a collapse that could easily exceed the plunge in the fall of 2008.
So all eyes will be on the Fed next week, and Euroland every day for some time to come. The US and global economies are on the verge of falling into another severe recession. Stock markets are on the verge of collapse.
Tensions are high. It won’t take much to trigger another global financial crisis.
In the past, we advised folks to buckle up. This time, we recommend you put on your helmets.