Equities Bruised, but not Battered

Once again, US equities suffered a week of losses. The S&P500 finished down 1% on even higher volume, meaning that this time the selling did become more meaningful. Along the same lines, volatility spiked slightly above 30 (on the VIX) for the first time since 2011. So some level of fear, albeit not true panic, did enter the US stock markets as the selling peaked last Wednesday.

Technically, the S&P500 is now a bit oversold on the daily charts. When prices fell the most, they crashed well  below the 200 day moving average, and the week’s decline was strong enough to bend the 50 day moving average to slope downward. But despite all of this, the 50 day moving average is still well above the 200 day moving average, and the 200 day moving average is still sloping slightly upward, or at worst, it’s flattened out. Again, both the 50 day must cross beneath the 200 day and the 200 day must slope downward for most technicians to call the beginning of a new bear market phase.

Now that the S&P is oversold on a short-term basis, everyone will be looking for the bounce, which—to be fair—had already begun last Thursday and Friday. The first challenge will be for the S&P to return back up to the 200 day moving average; and as of Friday, this hurdle had almost been overcome. At that point, the 200 day may act as resistance (or a ceiling over prices) because many of the investors who had spent the previous two years buying on dips to the 200 day moving average will be breaking even (ie. recouping their paper losses). Very often, due to human nature, these investors will have an inclination to get out (ie. sell) once they return back to breakeven. If this happens, then the S&P could turn back down.

If on the other hand the S&P sails upward and through the 200 day moving average, then the next and final hurdle will be the 50 day moving average. Very aggressive “dip buyers” used this average to buy, and only when or if prices return to the 50 day will they break even. At that time, once again, there will be a tendency among many of these aggressive dip buyers to get out by selling, so prices may turn down at that point as well.

Only if the S&P retakes the 50 day moving average will the coast be clear, and the road to full recovery will open up.

Finally, let’s step back and assess the overall damage from this worst stretch of selling in over two years in US equity markets. At the lowest point last week, the S&P500 only approached—but did not cross into—a 10% loss, which is the hallmark of a true correction in equity markets.

So despite all the headlines and supposed pain, the S&P500 has still not incurred a normal correction since 2011—over three full years!

Bottom line: stocks have been merely bruised. By no means have they been battered!

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