Dead Cat Bounce in US Stocks?

Just as expected, the S&P500 bounced back a bit last week. The only real surprise was that the bounce was only about 40 points, or 2%.  As noted, the S&P can rally well over 100 more points before running into overhead resistance. Volume was very light, which is screaming the message that nobody is really jumping back into the stock market even when prices rise a bit. Volatility continued to fall off, but it still ended the week at far higher levels than were typical during the sleepy summer months.

There wasn’t too much in the way of economic reporting last week. Initial jobless claims met expectations…exactly. Wholesale trade missed. Producer prices, both headline and core, came in much higher than economists predicted. And consumer sentiment totally collapsed—it recorded its biggest miss (vs. expectations) on record.

Now let’s look at the technical picture. As mentioned, last week’s bounce was not unexpected. The only real surprise was that it was only about 40 points. What’s critical to remember is that the 50 day moving average has crossed below the 200 day (for the first time since 2011) and that the 200 day moving average has begun to slope downwards (also for the first time since 2011). These two developments have been profoundly bearish in the past.

What makes the 40 point bounce surprisingly small is that the S&P can rally all the way back up to roughly 2,070 before technical overhead resistance (think of it as a ceiling) starts to put a lot more pressure on stocks. Why? because that’s where a lot of the most recent (most likely mom and pop) stock buyers bought their stocks, and they naturally will want to try to break even. As soon as they do, they will start to get out….by selling.

Does this mean that the S&P will certainly return back up to the 2,070 level? Not at all. There’s a reasonable chance it won’t even get there before turning back down again. But if it does, there will be a lot of sellers who will certainly be looking to get out.

In the meantime, until the 50 day crosses back over the 200 day moving average AND the 200 day returns to an upward slope, we must be prepared for rallies to fail at or around the 200 day moving average.  Remember, this is the exact opposite of what’s been happening over the last three years—investors always bought the dips, especially the ones close to the 200 day moving average. And now, investors must be prepared to sell the rips….for the first time since 2011.


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