The S&P500 eased back 0.7% last week on light volume. This was by no means a serious sell-off, in terms of percent decline or volume. While volatility (VIX) did jump a bit, it still closed near mult-year lows, meaning that even this slight jump in volatility did not chance the fact that the US equity markets are still in a state of complacency.
Technically, equities are very overbought, despite the small price retreat last week. Momentum is still positive, and all trends are still pointing upward. And valuations are still near multi-year highs. The conclusion—yes prices are still clearly rising, but that doesn’t meant that stock prices are a good buy or that they are safe to own.
US macro results mostly disappointed last week. Initial jobless claims were a bit worse (higher) than expected. Retail sales missed badly—both the headline and ex-autos figures came in well below consensus estimates. Producer prices, both headline and core, came in lower than expected, and finally, consumer sentiment registered its biggest miss in almost two years.
Despite the persistent overbought, overvalued and over-bullish state of the US equity markets (a syndrome best described by long-time money manager John Hussman), the equity markets have continued to climb upward to ever higher levels. Over the last 80 years (with the exception of the tech bubble in the late 1990’s), whenever stocks have reached even less extreme overbought, overvalued and over-bullish conditions, markets have always corrected, and usually quite severely.
But this time they haven’t, very much like they didn’t in the late 1990’s when they continued to march higher and higher until certain valuation metrics reached levels never seen before in US equity markets.
Still, even after climbing much higher, and much longer, than many experts thought possible, they ultimately did crash. The S&P fell over 50% and the NASDAQ fell over 70%.
This time around, the main driver of the seemingly unstoppable rise in stock prices is the belief that since the Fed is still printing money (via quantitative easing, or QE), then one should—actually must—be heavily invested in stocks.
And this brings up an important question—if the belief in the Fed…..that you should never fight the Fed—is one key driver of this bull market rally, and since the Fed has long since announced that it will be ENDING its expansionary monetary policy in a few short months, then why are stock market prices still rising?
Is it because investors now no longer really need the Fed watching their backs? Or is it because investors have not yet fully processed the fact that the Fed’s easing is about to end?
Later this week, the Fed will make another policy announcement which most Fed-watchers expect will include another small reduction in the current QE program. Perhaps this latest reduction will finally test the US equity market’s resolve. And if not, then in a few short months, QE is scheduled to fully cease. And then, for sure, we will find out just how much the US stock market valuations depend on the Fed’s electronic printing press.