Tis But a Scratch

Well so much for that bounce….from two weeks ago….because it lasted only 5 days. Last week the S&P500 slid over 3% and ended the week at its low point. Volatility surged over 22%, suggesting that there was conviction in the selling. Volume jumped on the big down days, even though total weekly volume was not huge, due to the loss of a trading day because of Memorial Day.

As expected last week (“the downturn and the selling are not over”), the US equity markets resumed their downturn. What’s worse, most of the year-to-date gains have now been almost erased. The Dow, in fact, is now in negative territory for the year.

US macro news has gone from bad to worse. Home prices fell more than expected, as reported by the highly respected Case-Shiller index. Consumer confidence sank. Pending home sales plummeted. Initial jobless claims jumped way above expectations, and are now creeping closer to the traditional recessionary boundary of 400,000. Chicago PMI badly missed, hitting the lowest level since September 2009. ISM manufacturing also missed, as did personal incomes. The big number of the week—and the biggest shock of the week—was the payrolls number which badly missed expectations, by coming in at only 69,000. Headline unemployment reversed course and rose up a little, as did the more broad (and accurate) U-6 figure. Average hourly earnings rose by half the expected rate. And when the 204,000 imaginary Birth/Death jobs are factored out, it’s clear that jobs may have actually gone negative in May. It looks like the US is joining the rest of the world…..back in recession. The question now is: how severe will the slowdown be?

Technically, the S&P500 is still oversold on the daily charts. It wouldn’t take much good news—even if fleeting—to generate an oversold bounce. But the weekly charts (as mentioned last week) are still overwhelmingly bearish. There is STILL more much more room for the S&P to drop. Also discussed last week was the sanctity of the 200 day moving average, which was in fact violated on Friday at close. This suggests that support is eroding, and that even if we see a bounce in the short-term, more selling could take the S&P down well below 1,250 and closer to 1,200.

And from a bigger picture perspective, let’s remember that the S&P500 is down ONLY about 10% from its April and May highs. This is truly only a “scratch”—nothing to sneeze at, but also nothing to  fear. So far.

The real test would come at levels closer to 20% below peak. This is roughly where the biggest drops in 2010 and 2011 ended, and formed the foundation for larger multi-month rallies.

And while 2012 so far seems to be following almost the same script, it’s far to early to know if we’ll fall as far before policy makers (most importantly, the Fed) panic and rev up the printing presses.

And it’s far too early to conclude that if (or when) the Fed steps in that it will have the same effect on   equity prices. The results over the last three years are pointing to a disturbing trend—while Fed programs do boost stock prices, each successive program boost prices by a smaller percentage and for a shorter period of time.

There’s a chance that even if the Fed jumps back in with another Operation Twist or QE3, the markets will not move very much, or for very long.

After all, the US 10 year Treasury rate plunged to 1.45% on Friday, which is near the lowest level ever reached in the history of the nation.

How much of a benefit—to the economy or to the stock market—will a further push down to say 1.2% have?

Arguably, not much. Especially since nothing seems to have worked for the US economy (in terms of reaching escape velocity) with all the prior stimulus programs.

Another dose, of the same failed medicine, might not do much good.

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