Something’s Gotta Give

The S&P500 ended last week up a fraction—it closed on Friday up 0.24% for the week. Volume was very light. And volatility drifted lower, close to the lows reached in February. Essentially, the S&P500 was treading water and looking for some sort of signal to find a direction for its next meaningful move.

US economic reports were mixed so these provided no clear direction for US financial markets. On the positive side, the housing market index, housing starts, consumer sentiment, and leading indicators all beat expectations. On the negative side, labor market conditions, initial jobless claims and industrial production all missed. At the same time, many reports (including consumer prices, retail sales, and business inventories) came in exactly as expected.

In terms of technical analysis, the S&P remains extremely stretched….obviously to the upside….on both the daily and weekly charts. The short-term parabolic jump that began after Donald Trump won the presidential election is still in effect.

Last week, we discussed how arguably the world’s most important commodity—oil—was diverging from US stock prices. Specifically, as stock prices remain near record highs, the price of oil, which originally crashed in 2014, has resumed its decline by dropping almost 10%. And it continued to creep downward—again—last week.

This week, we’d like highlight how S&P500 aggregate earnings have started to diverge significantly from the overall price of the S&P500. While the correlation over the last 10 years has —- for obvious reasons —- been positive (ie when corporate earnings rose each quarter, the price of the S&P500 rose in tandem with those earnings). But starting in early 2016, the reverse has happened:  GAAP earnings have not recovered; they’ve stayed flat. At the same time, the S&P500 has soared.  This is another very important divergence, arguably even more important than the divergence from the price of oil,that must be resolved on way or another. Either GAAP earnings must rise sharply to match the lofty prices of the S&P500 or the S&P500 must drop precipitously to match the depressed level of corporate earnings.

Once again, we need to wait and see how this convergence plays out exactly.

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