And the Bounce has Arrived

Not unexpectedly, the S&P500 did rebound last week, rising about 0.8% to put a stop, at least for a while, to the modest losses that had been incurred over the last month. Volatility melted back down, as one would expect. But volume–although moderate for the week–was light on the up days and strong on the down days. This suggests that investors were not coming back in droves to buy the dip.

US economic news last week was especially dismal. Let’s start with the ISM manufacturing index which registered its biggest miss (vs. expectations) on record and its biggest miss (in raw points) since 2008. Factory orders registered their biggest drop in five months. Ominously, factories built up their inventories at the fastest rate in 15 months; this means that, if end sales don’t pick up soon, factories will have to reverse this inventory build by slashing production—-and almost always, this leads to a recession. ISM services only met expectations. International trade figures for the US showed a greater deficit than expected; this will lower upcoming GDP figures. And the big number of the week—payrolls—disappointed, badly. Instead of rising by 181,000 as expected, US payrolls grew by only 113,000. Perversely, the headline unemployment rate dipped to 6.6% but only because unemployed folks keep dropping out of the labor force. The average work week and average hourly earnings failed to show any growth at all. In short, the US economy is still struggling to gain traction, and as of last week, it’s showing signs of slowing down. Not good.

Technically, the S&P500 just experienced a classic oversold (on the daily charts) bounce. During the drop, the S&P crashed through the 50 day moving average, and while not quite reaching the 200 day moving average, it bounced right back up to the 50 day moving average. Because it bounced back up to the 50 day from beneath it, this moving average will now act as resistance, or a ceiling, that will impede further gains.

Why? Because for the last year, traders were trained to buy all the dips to the 50 day moving average, and when the index bounce off the 50 day, they were rewarded with immediate gains. This time, the index sliced through the 50 day, causing all those dip buyers to face paper losses. And now that the index has recovered to the 50 day—the level where many of the dip buyers entered the market—they will tend to exit their trades at a break even price, and thereby successfully avoiding the pain of turning paper losses into booked or actual losses.

This means that the next test will be the price action around the 50 day moving average. If the index grinds upward and through the 50 day, and holds above it for a while, then the buy-the-dip crowd may return. But if the 50 day moving average does act as a ceiling and arrests further upward movement, then the short traders will gain confidence and jump in. This will push the index back down, making the 200 day moving average the next major line in the sand.

The upcoming week will be telling.

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