US Equities—Worst Ever Start to a Year

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?

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