Is “Buy the Dip” No Longer Working?

In a roller coaster week, the S&P500 finished up slightly; it rose 0.4% on light volume. Volatility dipped again a bit, returning back to the lows of 2013. But the weekly rise was anything but smooth and uneventful. While stocks crept up in the first half of the week, they ended the week with a violent sell-off on Friday.

Despite the Friday sell-off, technically, the S&P is still in a firmly established uptrend. Prices are over-bought as the continue hugging the upper Bollinger band on the weekly charts. While not as extended, price are also stretched on the daily charts. But market internals are weakening. For example, the percent of stocks above their 150 day moving average is falling, even as the price of the index rises. Also, the new highs minus the new lows index is just about zero, which is usually not something you’d see in a healthy rising market.

In terms of US macro news, the news was almost uniformly poor. At the start of the week, Chicago PMI missed badly. The PMI manufacturing index also missed, as did ISM manufacturing. Initial jobless claims were worse than expected. International trade was far worse than expected. And ISM services also missed. The big disappointment of the week was the payrolls report which came in weaker than expected. Headline unemployment (U-3) also did not dip as predicted. And average hourly earnings showed zero growth.

More and more economic experts, many from the Fed itself, are coming to the conclusion that while QE did help to boost investors’ asset prices, QE did very little to stimulate the real economy, the economy on Main Street. Over four years after the so-called “recovery” began, the US economy has not only failed to reach escape velocity, but it’s actually looking like it’s weakening further.

Finally, something interesting happened in US equity markets, but in small caps (Russell 2000) and tech-oriented businesses (NASDAQ composite). Over the last year and a half, whenever the S&P500 touched or dipped below its 50 day moving average, soon after, it bounced and bounced big….rising for several months and setting new highs.

But last week, something different happened with the Russell and NASDAQ. Each dipped below its respective 50 day moving average sometime near the end of March. But this time, each index—for the first time in almost two years—failed to rally for several months and failed to set a new high.

Usually, this is a bad omen for the entire US stock market, because these indices reflect the fortunes of smaller and more economically sensitive firms, and the failure in both of the above indices is a warning that the entire stock market, dominated in value by the S&P500, might be facing a more serious correction.

For the last year and a half, buying the dip—especially at the 50 day moving average—has been a winning investment and trading strategy…each and every time it happened.

But this time it failed, in two major indices.

This could mean that “buy-the-dip” may no longer work. We’ll know in a week, because for this to strategy to be re-affirmed, the Russell and the NASDAQ must come roaring back immediately.

Otherwise, we should all prepare for a more serious correction.

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