In what appeared to be a pause, the S&P500 dipped 0.1% last week, ending the week essentially unchanged from the prior week’s close. Volume was light, but that was partly due to the President’s day holiday that took away a trading day. Volatility rose slightly, but it’s still firmly holding on to levels associated with complacency about downside risk.
Technically the S&P is certainly in an overbought condition, both on the daily and the weekly resolutions. Prices have rapidly returned to their familiar spot—hugging the upper Bollinger bands, bands that point to an overbought condition. Bullish signals with respect to the moving averages have also returned. Prices have crossed back above the 50 day moving average, with relative ease, just as they have done so for the last 14 months. The 200 day moving average was never broken.
So does this mean that the bull trend continues? It appears so, but this does nothing to alleviate the extreme overbought condition and more importantly, the extreme overvalued condition. The Shiller PE is in an extreme danger zone, a zone that has been associated with new bear markets every time since the Great Depression (except for the tech boom of the late 1990’s). The only way this condition can correct itself is with a massive drop in equity prices, or with the attainment of a permanent plateau in earnings relative to sales and GDP, which—if it were to happen—would be the only time in history that something like this happens.
At the same time, other markets are not so bullish. Commodities are still struggling to reverse their multi-year losing streak. High yield credit has not jumped back nearly as much as equities have, and Treasuries are have sold off only slightly, meaning that a large amount of money is still taking shelter in Treasuries (rather than jumping back into equities).
So here we are again, right back to the melt-up trend that began over a year ago. The sell-off in January has essentially been reversed and everyone is now looking forward to new highs in the stock market….as usual, in the face of a struggling US economy. As long as corporate earnings don’t collapse, this trend can continue. But as mentioned above, earnings always, always revert back to the mean, when compared to sales and GDP.
This time will be no different. What is unknown, clearly, is the timing.