Another US Equity Bubble is Blown

After hovering, or essentially going nowhere, for two straight weeks, the S&P500 dropped 0.7% last week on light volume. Volatility, meanwhile, crawled back up, which is perfectly normal in a week in which the price index declined. That said, the VIX index is still near the lows of the year, meaning that investors are far from being overly worried.

Last week’s economic news was mixed. The Chicago Fed National Activity Index inched up, improving slightly over the prior month’s reading. New home sales beat expectations. Durable goods orders also beat expectations, and initial jobless claims were slightly lower (or better) than predicted. On the down side, existing home sales missed consensus estimates. The Richmond Fed manufacturing survey also disappointed. PMI manufacturing flash fell, instead of rising as expected. The Kansas City manufacturing index contracted again. The FHFA house price index disappointed. And finally, consumer sentiment missed badly—instead of rising as expected, it fell from the prior month’s reading.

The slight decline in the S&P500 last week did little to change the technical picture. On both the daily and the weekly charts, the S&P is still extremely overbought. But on the daily charts, a slight topping formation is beginning to take shape. This suggests that at least in the short term, some sort of correction may be in the cards. But on the longer term weekly charts, prices still look like they’re simply stretched to the upside. And since prices have moved well above the 200 day moving average (which itself has turned upward in terms of slope), many technicians will switch to trading the index from a bull market perspective—they’ll buy the dips towards the 200 day moving average, and they’ll sell the rips, or big surges well above the 200 day moving average.

So not, over seven years after the S&P500 bottomed (March 2009), the US Federal Reserve has succeeded in blowing another major bubble in the US stock markets. This is the third major bubble in the last 16 years: the first one peaked in 2000 and the second one in 2007.

As always, this doesn’t mean that this market is about to crash. But it does mean that when it does finally correct….in a meaningful way….that the downside will probably be far more severe than it would have been if another bubble had not been engineered.

This also means that for anyone who’s invested in US stocks to actually benefit from this bubble, they will have to sell out of the markets well before any bear market arrives. And unfortunately, any simply study of investor behavior—in the run up to bubble peaks and in the subsequent declines—shows that almost all investors fail at this last, but crucial, step. Almost everyone who enjoys the ride up will ultimately suffer on the way down, because they invariably fail to exit at, or near, the peak.

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