Trouble Ahead?

Well, the damage to US equity markets seems to be growing. Instead of continuing to bounce back, as it has for the last nine months, the S&P500 reversed course and dropped 2.1% to log its biggest weekly loss in 2013. Volume jumped. This is not good, because it suggests that there was growing conviction behind the selling. And volatility, as measured by the 30 day VIX, jumped to its highest levels in 2013. Also not good. Complacency seems to be melting away.

Technically, the S&P is now approaching areas where technical damage becomes a greater concern. For the first time in 2013, the S&P500 has decisively fallen below its 50 day moving average. On the other hand, the S&P is still well above the 200 day moving average, and this average is still trending up. Both of these pillars of support would have to break, before we can safely declare that the recent bull market push higher has ended. At the same time breadth indicators are pointing to more trouble ahead. The percent of stocks above their 50 and 150 day moving averages is tumbling badly. Also, in terms of breadth, the new highs less new lows index is collapsing, to levels last seen in the summer of 2011 when the S&P500 lost almost 20%.

At the same time, the US economy is far from reaching a healthy ‘escape velocity’. Most indicators are poor or mixed, at best. While the Empire State Manufacturing Survey jumped, all of the important sub-indicators missed. The sole reason for the beat was a huge spike in hope, hope that things get better in six months! Consumer prices, both headline and core, were subdued, meaning there’s little evidence that inflation is building, which typically happens in a healthy and growing economy. Housing starts missed, but existing home sales beat expectations. Initial jobless claims jumped, above the prior week’s levels and above the consensus forecasts. The Philly Fed beat, but the leading indicators missed. The shocking news of the week came from the Federal Reserve, which announced formally that it is will seriously consider tapering its permanent monthly QE buying program. The news was shocking mostly to the markets which were hit hard.

So now many investors are asking a critical question—should the US stock market be bought on this dip? This investment strategy has worked wonders for not only the last year, but ever since the  markets bottomed in 2009 when the Great Recession and the Global Financial Crisis were peaking.

Why not do it again?

Well there happens to be a major difference in this sell-off, and it has little to do (directly) with the stock markets. Yes, the stock markets are showing—so far—the same pattern as we’ve seen over the last four years: a healthy sell-off which offers a good, lower-cost entry point for putting new money to work.

But there’s a difference. This time, other markets are selling off ahead of the stock markets and more severely. US Treasuries, corporate bonds, emerging market debt, non-US sovereign debt, commodities (especially copper), municipal bonds, and others have taken it on the chin far more severely—on a risk adjusted basis—than US stock markets.

When was the last time we witnessed anything similar to this?

In late 2007 and early 2008. And we all know what happened next. The US, and global, equity markets didn’t just ‘dip’ afterward, they crashed.

Will something similar happen this time?

There’s no way to know for sure, but to simply buy the ‘dip’, this time could be very, very dangerous.

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