Treading Water

The S&P500 ended last week essentially unchanged from its close the prior week. Volume was very light—as one would expect in the middle of the typically quiet summer months. But volatility rose somewhat—not what one would expect with a market that didn’t drop in price or in the middle of a normally quiet summer trading week. That said, the VIX index is still far from showing any signs of fear among investors, as it hovers near decade lows, lows last seen in 2006-2007 close to the prior peak in the S&P500.

There wasn’t a lot of macro economic news reported last week, and most of it was mixed. On the positive side, initial jobless claims dropped below 300,000 and durable goods orders beat expectations—both headline orders and orders ex-transportation. On the negative side, the Chicago Fed National Activity Index fell from its reading the prior month. Flash manufacturing PMI fell more than expected. And new home sales fell far more than expected, with even the prior month seeing a huge downward revision. It looks more and more like the rise in interest rates (and therefore mortgage rates) has started to hurt the housing market, especially in the new construction part of the market.

In terms of technical analysis, the US equity markets remain extremely stretched—on the high side. Despite the lack of forward progress last week, the S&P is still hugging the upper Bollinger band on the daily and the monthly resolutions. Many, many indicators that technicians normally see oscillate between overbought and oversold over the course of a year have remained pinned to the “overbought’ side of the range for not just one full year, or two consecutive years, but now more than two consecutive years. Not that this is unprecedented, but in the last 100 years, the Dow has risen without at least a 10% correction only a couple of times. And of course, this doesn’t mean that the “overdue” correction is just around the corner. But it does mean that astute investors should be on the lookout for one, and that the longer the market avoids one, the greater the subsequent correction that does eventually follow.

Also, astute investors need to be aware that they can’t all—be astute enough—to get out of the market before any serious selling gets started. By definition, if everyone thinks they’re smart enough to exit before big selling starts, who’s going to be the dumb investor who will buy the stock….at the elevated prices….especially when most investors are bullish and solidly long the market already?

So as the summer of 2014 rolls along, it appears that the S&P500 is treading water, looking for some catalyst to push it even higher, or—for the first time in a long time—to push it lower and give it the much needed correction that takes some of the exuberant froth out of it. And even if the wars in Ukraine, the middle east and the current turmoil elsewhere in the world don’t provide the spark for a correction, then everyone needs to be aware of this one simple fact: EVERY time the Fed has ended new buying in prior QE programs, the US equity markets have corrected meaningfully. And the Fed is now only three months away from ending all new buying in its most recent QE program.

Tick, tock? We shall see.

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