Meanwhile in China……

After rallying slightly the prior week, US equities resumed their recent retreat, with the S&P500 falling 1.2% last week. While volume for the week was light, the day that the S&P dropped the most was the day that volume was the heaviest. And at the same time, volatility jumped, which is unsurprising during a week when prices fell. That said, the VIX is still well below panic levels, so investors are more complacent than they are fearful.

The technical picture suggesting a distribution pattern continues to become clearer. After last week’s mild loss, the S&P500 is now slightly down for the entire first half of the year. The last time this happened was in 2011, when the S&P500 proceeded to drop almost 20% before resuming its climb. As of now however, it’s down only about 3%. So even a run-of-the-mill correction, which is extremely overdue, would imply a drop of another 17% from peak.

On a short-term, say daily, basis, the S&P is no longer overbought.  And arguably, it’s somewhat oversold and due for an near-term bounce.  On a longer term, weekly basis, the S&P is still looking strong, but the broad distribution pattern is now beginning to become very clear.  This is important because all major corrections typically don’t come out of nowhere; instead the usually begin after the smart money has had some time to unload some of their shares onto the dumber money, sadly referred to as “retail”. This doesn’t mean that the long overdue sell-off is imminent, but that the conditions are very ripe for one.

In the real economy last week, we saw pending home sales, consume confidence and ISM manufacturing all beat consensus estimates. The bad news is that far more reports missed.  The Dallas Fed manufacturing survey, Chicago PMI, PMI manufacturing, factory orders and initial jobless claims all missed expectations. Even worse, the big number of the week—June payrolls—also missed.  Not only were fewer jobs created than experts had predicted, but average hourly earnings collapsed. Employees may not be losing jobs, but the ones they’re getting—often as bartenders and cashiers—-are part-time, with no benefits and with low pay. Also, the labor force participation rate dropped to 62.6% (from 62.9% the month before). This is the lowest level since 1977, or 38 years!  So as the US population continues to grow, a smaller and smaller percentage of it is actually working. This is not good.

While the world has been fixated on the massive problems in Greece over the last several weeks, another interesting bearish development has been developing in China. Since peaking well over 5,000 in early June, the Shanghai Stock Exchange has plunged about 30% in the last four weeks. Not only is this a bear market correction, but if it doesn’t stop soon, it has the potential for turning into a huge crash.

But why does this matter to anyone in the US?  Well, because the last time this happened was in 2007 when the Shanghai index rocketed from about 1,500 to about 6,000 in only a year. Then starting in late 2007 and continuing in the first half of 2008, the Chinese stock market crashed all the way back down to almost 1,500 again, losing about 70%.

So it’s not the fact that the Chinese stock market soared and crashed, it’s the fact that it crashed about six months before US stocks crashed. In other words, the Chinese stock market was a leading indicator. And if there’s any reason to think that history may rhyme again in the future, then US stock investors have plenty of time to de-risk.

The number of high-quality “warning signs” is growing by the month.

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