S&P500 Set to Retreat?

The S&P500 fell back another 1 percent last week on light volume. Volatility inched higher, as would be expected during a down week. But the VIX Index is still in fairly complacent territory, nowhere near levels associated with fear, much less panic.

Last week’s economic news was mostly disappointing. Jobless claims were a bit better than expected, and business inventories grew slightly more than predicted. But other than that, things were ugly. The labor market conditions index fell …… again. The JOLTS survey missed badly—job openings came in well below expectations. Producer prices, both headline and core, were hotter than predicted. And consumer sentiment crashed; instead of rising as expected, it fell considerably.

So all in all, the same old story for the US economy—very sluggish growth, with no improvement on the horizon.

As far as US equity markets go, the outlook is becoming even more troubling in the near term. As outline here over the last couple of weeks, the S&P500 has been forming a short-term topping pattern, and after last week’s 1 percent retreat in the S&P500, this topping pattern has been reinforced….if not confirmed. First, the uptrend line that began after the big bounce in February 2016 first began has now been violated. Last week’s decline broke this uptrend. Second, almost every major momentum indicator has already diverged bearishly several weeks ago, and now that the S&P has declined for a couple of weeks, this bearish divergence is being confirmed. Third, the most recent significant low point reached in early September (roughly 2,120 on the S&P) was broken last week. All this suggests that some sort of more meaningful retreat in the S&P is now more likely to occur in the near term.

And the lows reached in late June, immediately after the Brexit vote, would become a natural target for an impending downside move. This is roughly around 2,000 on the S&P, which represents a 6% drop from last Friday’s close.

Note that this is still a call for a relatively modest retreat. Given that the latest cyclical bull market is now about six years old (very mature), and given that corporate earnings have been falling for about two years, and given the super-high valuations in the S&P relative to long-term historical standards, a more severe retreat in the S&P would lop off about 50% of its value, which would take the S&P back only to average valuations. Any overshoot to the downside—which almost always occurs in bear markets—-would chop off far more than 50%.

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