US Equity Bounce Continues

After the prior week’s massive 3.8% bounce in the S&P500, last week the large cap index rose another 0.8%. Volume this time was much lighter, and volatility only dipped slightly—mostly because it had already fallen back by a huge amount the prior week.

In macro news, retail sales, both headline and ex-autos, beat expectations; so did the Empire State Manufacturing Survey. Unfortunately, business inventories missed. So did industrial production. Inflation—both consumer and producer—seems to be contained, with most of the numbers coming in at or below expectations. The other misses were the Philly Fed Business Outlook and the Kansas City Fed Manufacturing Survey. On the bright side, housing starts and initial jobless claims were both better than expected.

So the technical picture for the S&P500 is still consistent—the bounce that began strongly two weeks ago continued last week, but it’s beginning to lose steam. At the same time, because of the huge size of the two-week bounce, the S&P500 finds itself immediately in very overbought territory…..well above the 50 day moving average and hugging the upper Bollinger band. So suddenly, the S&P500 looks like it’s poised for a pullback, at least in the short term.

Meanwhile, on a valuation basis, the S&P500 is pushing up against 100 year extremes in terms of the median Price to Earnings ratio, Price to Sales ratio, and Price to Book ratio. And a minor pullback will not even come close to correcting this extreme condition. What would? A drop of at least 50% would only bring the S&P500 back in line with 100 year averages….in these same ratios.  To become as undervalued…..as it is overvalued today…..the S&P500 would have to fall closer to 60-75%. While this sounds absurd, we must not forget that almost all bubbles that burst end up falling by this type of percentage. In fact, many prior bubble markets have collapsed by falling more well more than 75%. Will this time be different?

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