US Equities Bounce…..Will the Selling Return?

January 25, 2016

After a horrific start to the new year, the S&P500 managed to stage a last minute rally (on Friday) and close the week up about 1.4%, but that was after suffering another frightening loss earlier in the week when the index fell to intraday lows that were last seen only in 2014. Volume was also heavy, but not as heavy as in the prior week when the index finished down for the week. And volatility dropped off by Friday, as one would expect when the index rallies in price.

News flow was light on the economic front. The housing market index missed expectations. Consumer prices came in lower than predicted….or hoped for; in other words, by official government measures, there is no inflation threat for American consumers. Housing starts missed. Initial jobless claims also missed; they jumped back up just beneath the 300,000 level. The Chicago Fed National Activity Index fell. On the positive side, The Philly Fed Business Outlook Survey fell, but just not as badly as expected. PMI Manufacturing Flash beat expectations, and so did existing home sales.

The technical picture is clearly showing a market that after selling off hard for several weeks wants to bounce back with some sort of relief rally. In many ways, this would be very unsurprising if it happened. Even in clear bear markets, stock indices don’t fall every day or every week. So if US stocks rallied this week and next week, this would be very normal.

On the other hand, the technical damage recorded in the S&P500 over the last several months (starting in August 2015 and ending last week) is extremely compelling and very bearish—several lines in the sand have been crossed. And this means that many dip buyers who have been accustomed to loading up on stocks every time they dipped are now sitting on losses. These buyers will be looking to reduce their losses. How? By waiting for prices to bounce back just enough for them to “break even”. The problem for US stock markets with this sentiment is that all rallies will be sold; in other words, all rallies will be looked upon by dip buyers as an opportunity to eliminate paper losses. So the real problem for all long-term investors, is that there is a lot of pent up selling pressure just waiting to reveal itself. And this will make it very difficult for US stock prices to rise a lot more… least for a while.

So all eyes will be on the bounce from last week. Will it last? If so, how much more will it last before the pent up selling pressure reasserts itself?

US Equities—Worst Ever Start to a Year

January 19, 2016

Shockingly, the S&P500 managed to register another losing week, this time shedding a little more than 2%, leaving the key index about 12% off its all-time high which was attained in mid-2015.

This time volume did jump and this implies that some investors were simply selling stocks to reduce their exposure to the equity markets; during the past three years, the more common way to reduce equity market risk was to hedge with insurance (eg. buying put options) instead of getting out of equity positions outright. This is not a good sign because it signals a potential shift in trader sentiment towards a more bearish view.

Volatility also jumped a bit, but this was to be expected. The VIX index surged above 30 for the first time since August 2015, but even so, this jump is still not significant enough to signal a serious panic among stock owners.

On the US economic front, essentially every report was a disappointment. Initial jobless claims jumped more than expected. Export prices fell a lot more than predicted;this will eat into corporate earnings. Retail sales missed. but more importantly, when the volatile auto figures are excluded, retail sales fell—instead of rising as predicted. The Empire State manufacturing survey utterly collapsed. Industrial production fell twice as much as experts had predicted. Consumer sentiment fell; it was supposed to stay unchanged. And finally, business inventories dropped, instead of remaining unchanged as expected. In short, the US economy is now more clearly than ever, lurching toward another recession.

In terms of technical analysis, the US equity markets are oversold, and some sort of bounce—any bounce at all—would be most unsurprising. Many times this happens, after steep sell-offs, not because value-conscious buyers rush in to pick up bargains (again, the S&P is down only 12% from its all-time highs; “12% off” is hardly a deep discount), but because short sellers who’ve profited from the already registered price drops want to book profits, and to exit their profitable short trades, they mush buy stocks. This “short covering” alone is sometimes enough to arrest a steep drop….at least temporarily.

To put the loss this year into context, it should be noted that the first three weeks (-1%, -6%, and -2% last week) add up to a total month-to-date loss of about 9%. While it doesn’t sound like a terribly large amount, it shockingly does set a record—this month-to-date loss is now the worst ever loss over the first three weeks of any year for the S&P500.

And while we’re overdue for a short term bounce, very often, after the bounce has run its course, the former “buy on the dips” investors who have transformed their mentalities to “sell on the rallies” will look to the bounce (or rally) as an opportunity to reduce their long exposures further. This will then put more downward pressure on the S&P500. And at that time, things could get interesting because the last time the S&P convulsed was in August 2015, dropping down to about 1,867, which has now become a major line-in-the-sand that if not held may cause investors to get out of the equity markets in far greater volumes than we’ve seen so far.

The next couple of weeks will be telling—will 1,867 on the S&P hold? And if not, how far will it drop if it doesn’t?

US Stocks Tumble…Badly

January 11, 2016

In one of the worst weekly performances in many years, the S&P500 lost almost 6% on moderate volume. Volatility jumped—the VIX index rose to the upper 20’s, the highest level since the August 2015 panic sell-off.

So not only did the Santa Claus rally fizzle last week, but as predicted last week, the US equity market was ripe for a more serious drop:

…beneath the surface, this market has become very dangerous for a long time now. And markets like these, when breadth deteriorates badly, are the very ones prone to crashes and major corrections.

Again, this is no guarantee that a crash or major correction will happen anytime soon. It’s just an observation that almost all US equity markets that have crashed in the past have looked eerily similar to the one that we see today.

And a 6% drop in only five trading days is a “serious drop”.

Before returning to the S&P, let’s touch on the US economic results, most of which were very weak again. ISM manufacturing missed (falling, instead of rising as expected). Construction spending cratered. PMI services fell. ISM services missed. Initial jobless claims missed. Wholesale trade also missed. And while the headline payrolls report looked strong, beneath the surface, things were not so rosy. Most of the jobs created were low paying jobs without benefits and usually part-time (think bartenders, waiters, etc.). Also the birth-death model conjured up several hundred thousand new jobs, without which, almost zero new jobs would have been created. And the number of folks out of the labor force (because they can’t find jobs) is still at record highs, so the unemployment rate is not nearly as strong as it looks—-ie. if all the people who want and need jobs actually looked for them, the unemployment rate would be closer to 10%, not the reported 5%. Finally, average hourly earnings stagnated, instead of rising as expected; this also suggests that while new jobs may be created, they don’t pay much, and it also suggests that existing workers don’t have much leverage to ask for and get pay raises.

The technical picture is now somewhat confusing for many market experts. Over the last three years, whenever US stocks have fallen anywhere near 10% (and most of the time the drops were less severe…..closer to 3-5%), it ended up being a great opportunity to “buy on the dip”. Why? Because the S&P would invariably, recover the initial loss and then proceed to set new all-time highs. Dip buyers have always been rewarded since 2011.

But this time, some market experts are asking if the fact that the “bounce” after the panic sell-off in August 2015 did NOT lead to a full recovery and it did not lead to the setting of new all-time highs together mean that investors should tread more carefully. This time, the highs were lower than the prior highs…..and this is a very ominous sign, because for the first time since 2011, dip buyers were not rewarded the same way. Instead, these market experts are now trying to determine if the market sentiment has changed to one where investors “sell the rallies”, in which case we’d expect to see a string of lower highs and just as importantly, lower lows.

How will we know for sure? Well since the higher high failed to be established post-August 2015, now we need to see if a lower low can also be set. This means that the lows of August must be tested….and broken to the downside. This KEY level is 1,867 on the S&P500. If this is reached, breached and not held for a daily close, then a LOT of market players could decide to get the hell out of dodge. The problem is that below 1,867 there is no obvious and strong support level….anywhere nearby the 1,867 level. Instead, the really meaningful support is somewhere almost 25% lower! And that’s a scary thought.



The Santa Claus Rally Fizzles

January 4, 2016

Well, it started on a good note—the S&P500 edged higher early in the week, but it gave up all its gains—and then some—by the end of the holiday shortened week. Volume was light, again due to the holidays, and volatility, as measured buy the VIX index, crept higher….naturally, as prices retreated.

US economic reports were very weak last week. Almost all disappointed. The Dallas Fed manufacturing survey kicked off the week with an abysmal drop—notching its lowest reading since 2009. The Case Shiller home price index (non-seasonally adjusted) also missed badly. Pending home sales missed. Jobless claims jumped notably. And the big shock of the week was the Chicago PMI which collapsed from 48.7 to 42.9 (it was expected to rise to 50.0). This was its biggest miss ever, and more importantly, when it’s reached these levels in the past, the US has always entered a recession.

So the warning signs that the US economy is finally going into a recessionary phase are growing. Remember, it’s been about 8 years since the last recession began. In other words, based on past historical economic cycles, the US is due–actually overdue–for a cyclical recession.

The technical picture became much more grim last week, primarily because the Santa Claus rally failed. Not only did the S&P500 record one of its weakest Decembers in many years, but the rally couldn’t even succeed in the week between Christmas and New Years Day, a time that almost always shows gains in US equity markets.

For those who’ve been following the year-long topping and distribution pattern in the S&P, this failure should come as no surprise—all year, the S&P has seen professional and institutional owners of stocks sell their shares to mom & pop retail buyers who always—always—are last to join any party in stocks. This shift in marginal buyers from pro to amateur, plus the extremely narrow leadership of a handful of hot mega-stocks (think Amazon), has made the S&P500 appear to be preserving its value.

But beneath the surface, this market has become very dangerous for a long time now. And markets like these, when breadth deteriorates badly, are the very ones prone to crashes and major corrections.

Again, this is no guarantee that a crash or major correction will happen anytime soon. It’s just an observation that almost all US equity markets that have crashed in the past have looked eerily similar to the one that we see today.