US Equities on the Brink?

Something very unusual happened last week. For the first time in two years, the S&P 500 touched the 200 day moving average. And the S&P 500 did not roar back up after a couple of consecutive weeks of losses.

Volume jumped, but certainly did not explode the way it would if a major risk-off event, ie a crash, were to occur. And volatility, as measured by the VIX, spiked above 20 for only the second time in 2014; but once again, this is not indicative of a panic sell-off when VIX can smash above 30, 40 (as it did in 2010 and 2011) and even 80 (as it did in 2008).

How bad was the damage? When the week ended, the S&P was down over 3%, registering its biggest weekly percentage loss since 2012.

Did something happen in the US or global economy to trigger this drop?  Not at all. In fact, very few economic reports were announced at all last week, and many were stronger than expected. Job openings, as measured by the JOLTS survey, beat consensus estimates. Initial jobless claims were lower than forecasts called for. And wholesale trade beat the estimates. For the week, only consumer credit missed expectations.

Did corporate earnings suddenly take a turn for the worse? Again, the answer is no. No major negative corporate surprises were announced.

Did anything highly unusual—a black swan event—take place to spook investors?  Also, no.

What appeared to happen was that a change in sentiment among investors started taking place. As predicted by some, with the end of the Fed’s latest QE program only a couple of weeks away—and with no other major central bank stepping in to replace the Fed’s printing—investors may be starting to batten down the hatches in preparation for much greater uncertainty, as the key driver of inflated asset prices over the last two years, the Fed’s open QE program, finally ends.

So will stocks continue to crumble?

Here’s one key indicator to watch—if stocks close below the 200 day moving average for a while, and then when they rally—as they inevitably will—the test will be the same 200 day moving average. Whereas for the last 2 full years, the 200 day acted as a rock-solid line of support (which savvy investors used to “buy the dip”), this time the 200 day may act as resistance, a type of ceiling, over stock prices and knock them back down when touched.

So if the 200 day begins to act as resistance, and stocks bounce back down when touching it, then there’s a good chance that two things will happen:  1. the 200 day will stop rising, and begin sloping downward, and 2. the 50 day moving average will cross beneath the 200 day moving average to create the “death cross”, which will be a very strong signal to many investors to GET OUT.

Until then, we must still wait. A true bear market will not start until these last conditions develop.

 

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