US Stocks—One Last Blow-Off Jump in Prices?

October 26, 2015

Well the S&P500 did meet its second big test last week. After retaking the 50 day moving average a couple of weeks ago, last Friday, it moved back above the 200 day moving average. Specifically, the S&P closed 2.1% higher on the week. Volume was modest and volatility continued sliding back down. That said, the VIX index is still about 50% above the lows reached during the summer months.

In economic news, there were only a few major reports last week and the results were mixed. Housing starts beat expectations but not due to single family home starts (a better measure of housing health) but due to multi-family home starts (more of a measure of investor confidence). Initial jobless claims beat expectations. And existing home sales also beat expectations. On the negative side, the Chicago Fed National Activity Index missed badly by registering a very negative result. Leading indicators also fell. And finally, the Kansas City Fed manufacturing survey reported a negative number….again.

The technical analysis picture is now becoming more bullish. While on the daily charts, the S&P500 has become somewhat overbought, and due for even a small pullback, the weekly charts are suggesting that the multi-week recovery in prices has more room to continue.  The next and final major test to confirm a true recovery in prices will be the reversal of the Death Cross and an upturn in the 200 day moving average. As of now, the 50 day moving average is still solidly below the 200 day moving average (the original Death Cross).  And this situation is far from being reversed; in other words, it would take far more than just another weekly gain of say 2% on the S&P to reverse this cross.  And also, the 200 day moving average is still sloping downward. This too would require many weeks of advances to reverse—ie. to bend the slope back upward.

So now that the recovery in prices is well underway, let’s see if the S&P500 has another major leg up left in its multi-year bull market. And if so, will this be the final “blow-off” top similar to what happened in 1998 and 1999 before a major bear market finally commenced? Remember, corporate sales and now earnings are falling for the S&P500 as a whole, and for prices to continue to rise, they will have to rise in direct opposition to sales and earnings trends. This does not usually happen, and if it does, not for very long.

Major Test for US Equity Markets Approaching

October 19, 2015

The bounce that began a couple of weeks ago continued last week, but this time the S&P500 rose only 0.9% so the rate of increase has slowed down considerably. Volume was modest, which also suggests that the driver behind the recent bounce is based more on short covering than on new money rushing back into stocks. And volatility continued to edge back down, as would be expected whenever market prices move upward.

On the economic front, last week’s results were notably weak. In fact, they were so weak (again) that many market analysts are pointing them to argue that the Fed will have to hold off on hiking interest rates, and therefore this by itself becomes a reason to stay invested in stocks. In other words, bad economic news may be turning into good news for risk markets. And specifically, last week, retail sales excluding the volatile auto sector cam in abysmally bad, well below expectations. Producer prices, excluding volatile food and energy, also plunged…..implying that a deflationary upstream situation is taking hold, and also implying weakness upstream in US production pipelines. The Empire State manufacturing survey fell much more than consensus estimates suggested it would. The Philly Fed business outlook also plunged. Job openings, as reported by the JOLTS survey, collapsed. Only consumer sentiment and initial jobless claims beat expectations.

In terms of technical analysis, a major test—one that’s been mentioned here for the last several weeks—is fast approaching.  Now that the S&P500 has been bouncing for a few weeks, and now that the closing prices have recaptured the 50 day moving average, the next major test is the 200 day moving average.  It’s a big test because for the last three years, traders have very successfully used pull-backs down to the 200 day moving average to put on new long positions. But this strategy finally failed in August, just a couple of months ago. So everyone who bought at the 200 day moving average in August has been underwater on those positions for about two months. And decades of investor behavior history suggests that whenever prices rise enough (and this applies to professional investors as much as it does for retail, mom-and-pop investors) to eliminate the losses, or break-even, that investors tend to get out of those positions because they’re happy that they’ve erased their recent paper losses. But as all these relieved break-even investors “get out” of the market together, their selling puts a lot of downward pressure on prices….near the 200 day moving average.

So if prices can not only reach the 200 day, but more importantly, overcome the huge resistance that will almost certainly hit them at this average, then they will have overcome a major hurdle, a hurdle that needs to be go away before prices can continue to move even higher. Of course, history also suggests that this resistance often holds. In other words, so many investors get out together, pushing prices downward again, that big selling returns.

We should which direction the US equity markets will take over the next week or two.

The S&P500 Continues to Bounce

October 12, 2015

As expected (from last week “when a big reversal like this happens in markets, there is often a decent follow-through. This means that the bounce that began last week can easily persist for another several weeks”), the S&P500 bounced some more. This time it surged about 3.3% on moderate volume. Volume was moderate, mainly because the evidence suggests that the surge in prices was caused more by short covering than by a rush of new investors into the stock market. And volatility dropped back down quite a bit, as would be expected during a week when prices jump. The VIX index fell almost 20%. That said, it still ended the week way above the sleepy and complacent levels seen over the summer months.

In economic news last week, the news was pretty much all bad. The PMI services index started the week off on a down note—missing expectations of a small drop by registering a large drop. The labor market conditions index also missed expectations. And the more important ISM services index plunged, vs expectations, because of collapse in new orders. Then, consumer credit fell, instead of rising as predicted. Import prices came in higher than expected; this puts even more pressure on corporate earnings. And finally, the inventory to sales ratio for the economy is screaming that a recession is imminent. Why?  When the US economy produces inventory (which adds to economic growth rates) but does not sell it (which does not necessarily detract from growth rates), the natural “fix” to this problem is to cut back on production of inventory, so that the excess ratio of inventory to sales can be reduced. But the result—driven by a drop in production—almost always leads to a recession. And this situation can now predicted with a high degree of confidence, because the ratio has now reached levels that match or exceed every other recent level that immediately preceded a recession!

Finally, as predicted last week, the follow through in the US stock markets continued last week. And the first hurdle—recovering above the 50 day moving average—has been met. But the second hurdle—recovering above the 200 day moving average—has not yet been achieved. And  for the “correction” to be declared over, this must happen. So all yes are now on the 2,060 level of the S&P, where the 200 day resistance now sits. Let’s see if the S&P can power through this level over the next week or two. If not, then we can easily see a resumption in the downturn that first got underway in August.

S&P500 to Bounce in the Short Run?

October 5, 2015

So the S&P 500 did rise in the last week, as we suggested it might do one week ago. The index logged a 1% gain and it did so on higher volume. But not to be deceived, the activity for the week was very volatile and on several days the index was down substantially intra-day, and on those days volumes moved markedly higher, only to end the day with gains. In other words, volume rose last week not simply because investors were pouring into the equity markets but because many investors were actually exiting the markets when the indices were down…..albeit intra-day. Volatility also see-sawed, spiking when the stock markets were selling off, but since the markets ended the week higher, the VIX index finished the week lower than the prior week’s close.

Almost every single economic report last week missed expectations. Some, like the Chicago PMI release, plunged down into clear recession territory. But the big news story of the week was payrolls, and it was a massive miss.  Instead of rising to the expected 203,000, up from 173,000  the prior month, payrolls came in at only 142,000. To add insult to injury, the average workweek fell, and average hourly earnings also disappointed. The labor force participation rate registered its lowest reading since 1977. In short, the US jobs picture was a disaster.

So what did equity markets do?  Counter-intuitively, they celebrated by jumping higher on the news.  Why?  Simple—they concluded that since the news was so bad, the Fed has no choice but to delay the much-anticipated rate hike in the fed funds rate, the first since 2007.  In fact, traders shifted their expectations on when this first hike would occur from late 2015 to sometime in late 2016.

And there you have it—the catalyst for the short-term bounce in US stocks that we described last week as a very plausible scenario.  And when a big reversal like this happens in markets, there is often a decent follow-through. This means that the bounce that began last week can easily persist for another several weeks.

Technically, the downside break that happened in August would not be reversed until stocks first regained the 50 day moving average, which will act as resistance (this is roughly around 2,000 on the S&P500) and then the 200 day moving average (this is roughly 2,060 on the S&P).  The resistance at the 200 day should be even stronger than the resistance at the 50 day.  In other words, many traders will be looking to “get out” of underwater positions that will reach break even around the 200 day moving average.

So now we need to wait and see if this bounce is just a short-term event that turns back down at resistance, or if it’s the resumption of the multi-year bull market. At this point, it’s nothing more than a bounce in a down market. But we will know with more certainty over the next few weeks.