Delayed Bounce in US Equities

Instead of bouncing in the prior week, US equities roared back last week, gaining 2.7% by Friday’s close. Volume was very light, but part of this can be explained by the holiday shortened week. Volatility was slammed back down, but not quite down to 2013 lows when complacency was ruling the equity markets. The VIX index closed on Friday at levels that were about 30% higher than those 2013 lows. This means that many investors are more nervous than they were last year, despite the higher equity prices this year.

Technically, the S&P500 has returned to an overbought condition on both the daily and the weekly resolutions. With last week’s bounce, prices have moved back up to the upper Bollinger bands. But interestingly, several momentum indicators are not matching the exuberance in prices. MACD and RSI are both much lower than they were at most recent peak prices. This is a negative divergence, and often implies that prices could follow weakening momentum…..down. Next week will be the deciding factor—if prices keep rising briskly, then this negative divergence will disappear. On the other hand, if prices reverse course and start dropping, then the negative divergence will have been an accurate early warning sign that prices were about to slip.

In US macro news, retail sales beat estimates, but this was done simply because consumers continued to raid their savings. This is fine in the short run, but will come back to haunt households who will not have enough savings for retirement….or will be forced someday to slash consumption to build savings back up. Consumer prices, both headline and core, rose twice as fast as predicted. The Empire State Manufacturing Survey plunged. The Housing Market Index disappointed, as did housing starts. Industrial production beat consensus estimates. Initial jobless claims seem to be approaching the 300,000 level, and the Philly Fed Survey beat estimates.

But the bottom line is this—the US economy is still limping along, crawling forward more than growing, and certainly not anywhere near achieving escape velocity.

So the 200 day moving average was not tested last week. Instead, the S&P500 inched back up over its 50 day moving average.  But recent highs have not been taken out. And this will be the real test for everyone conditioned to buy the dip, which they did again. This week, and perhaps next week, will be the time when these investors will expect to be “rewarded” for their steadfast commitment to buying at or near the all-time highs….on minor dips.

Someday this will strategy will fail, and when it does it will fail spectacularly. Because so many investors have been drawn into following this strategy, when it fails, the exit doors will not be large enough to accommodate everyone scrambling to get out.

But as usual, nobody knows when that day will arrive.

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