Stocks Not Out of the Woods

The S&P500 recorded a second consecutive week of increases, but this time the rise was about half the prior week’s gain—the S&P closed the week up 1.58%. But volume during this up week was much lower than it was earlier in February when prices fell, which means that investors are far from enthusiastic about this rally. If anything, short covering explains most of the jump over the last two weeks. Volatility did fall back, but only to levels associated with far more uncertain periods; in other words, the complacency we usually see during long periods of price rises did not return. The VIX index closed the week near the 20 level.

US economic news did not get much better last week. The PMI manufacturing index missed expectations. At the same time, it looks like the US housing market is losing steam, and fast, lately; the Case Shiller home price index is no longer showing home price increases. While existing home sales volume beat expectations, new home sales collapsed—-they registered the biggest percentage drop since 2009. Also in housing , the FHFA house price index missed expectations. PMI services not only missed badly, but they moved into contraction (ie. recession) territory. Consumer confidence absolutely collapsed. The Kansas City Fed manufacturing survey notched its worst reading since April 2009. And international trade came in far worse than expected. On the positive side, durable goods orders beat expectations, and both personal income and personal spending were slightly better than predicted. Finally, Q4 2015 GDP revisions were a little better, but only because unsustainable (and soon to be reversed) inventory builds were stronger than expected—final or end sales did not improve.

Now that the S&P500 has bounced for two consecutive weeks, as noted above, the question becomes—is this just a typical bounce within a new bear market decline…..or is this just the resumption of the 3 year bull market rally….first to return to the old highs set in May 2015 and then to set even higher highs after that?

To try to answer this question, we turn to clues in other non-equity markets, but markets that are often correlated to equity markets. And the most important ones to look at are the credit markets. First, the high yield market—which is considered, just as the stock market, to be a riskier asset category, but one dominated by professional investors only—is signalling that more pain lies ahead for US stocks. The reason is that the high yield market, which started selling off well before the dramatic turn down in the stock markets, has not recovered much at all. Spreads are still very wide and they show no signs of compressing. Second, the “safe haven” US Treasury market is also signalling that the coast is not clear. When investors embrace risk, such as stocks, they tend to sell off US Treasuries (which they consider a safe haven) to free up cash to put to work in stocks. When that happens, prices of US Treasuries fall (and their yields go up). Well that hasn’t happened. If anything, the opposite has happened—money has moved into Treasuries and yields are near cycle lows.

So while this stock market bounce has helped relieve some of the pain stock investors have suffered from since the start of the year, it’s far to early to determine if the dramatic downturn in stocks has truly ended and reversed.

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