For the second week in a row, the S&P500 lost a little ground. Not much, but -1.3% is still a loss. Volume was moderate, but usually greater on the down days. Volatility, as measured by the VIX jumped over 12%. But despite this jump, the overall level is still near multi-year lows, meaning there’s the potential for an explosive upside move.
Interestingly, several breadth indicators broke down a bit. The weekly McClellan Oscillator dropped into negative territory, implying that a price bounce would not be surprising. The slower moving weekly Summation Index also broke lower, but because it started from high levels, there’s quite a bit more downside left in this indicator. The exact same analysis applies to the percent of stocks above the 150 day moving average; it dipped, but there’s potentially a long way to go.
But why worry about downside, especially when everyone seem to be saying that you “shouldn’t fight the Fed”. Accept that QE3 will boost stock prices and just go with the flow—buy more stocks, and at the very least don’t sell any.
And this is the conventional wisdom, even though the S&P500 has lost ground in the two weeks after the Fed’s QE3 announcement.
But what about longer term? For stocks to reverse the two-week dip and return to their march onward and upward, the Fed’s latest QE program will have to overcome a slew of obstacles.
For one, the Fed’s QE will have to turn around corporate sales and earnings—both of which have been badly deteriorating over the last couple of months.
Also, the Fed’s QE will have to negate the certainly negative effects of the “fiscal cliff” that will be hitting the US in January. There’s no question that negative fiscal effects will occur; the question is only how severe will they be, and given that there’s a good chance that the political polarization in Congress will not go away over the next three months, then it’s very possible that a huge, shocking hit to the economy will arrive soon.
Then there’s the little problem across the Atlantic known as the euro crisis. Somehow, the Fed’s QE would have to counteract the shocking effects of the exit of one of more of the periphery states, which is becoming a greater risk every day, week and month.
And let’s not forget the hard landing in China, and the slow motion train wreck also known as Japan,which is now in its third “lost decade”.
Finally, there are the know geo-political time bombs, currently ticking away in the Middle East and lately in the South China Sea.
What are the odds that the Fed’s QE3 program be able to successfully negate the shockingly deflationary impact from any one of the above developments?
After two, albeit modest, weeks of losses, perhaps the US stock markets are on to something?