US Stocks Continue to Bounce; US Treasuries Yields Dip

February 26, 2018

After some up and down days during the week, by Friday’s close the S&P500 ended up almost 0.6% for the week. Volume was once again very light, meaning that investors were not rushing back into the stock market to buy the dip. Volatility, as measured by the VIX index, continued to climb back down from the recent highs reached in early February. That said, the VIX is still nowhere near the lows reached during much of 2017.

There was very little in the way of US macro news last week. PMI composite flash beat expectations, and so did initial jobless claims and leading indicators. On the downside, existing home sales missed badly, mostly due to the recent run up in interest rates.

With respect to technical analysis, the S&P500 shows no signs that the two-week bounce is over. In fact, the strong momentum generated off the 200 day moving average has pushed prices back above the 50 day moving average. That means that the “buy the dip” mentality and strategy, one that has worked so well for over a year now, may return. For this to happen, prices would need to fully recover their losses; they’d have to return back up to the all time highs set in late January and then go on to establish even higher highs.

If this doesn’t happen, then there could be a disastrous rush to sell….as everyone who looks to recover their losses starts to panic about incurring much larger losses than the relatively minor losses already incurred. In other words, after enjoying gains for several years, many investors will look to book the gains, and not risk losing them. The problem of course is that at these still elevated prices, there will not be enough buyers to get everyone out. So that means that only the first sellers, the earliest sellers, will have any chance at getting out at the higher prices. Everyone else, should a sell-off redevelop, will have to decide between realizing much lower price or staying put and riding out the retreat.

Meanwhile, one of the catalysts for the equity market sell-off, rising Treasury rates, is dissipating slightly. The US 10 year rate has backed down from almost 2.95% to the 2.88% level. While this is not a huge drop in yield, it does provide some more cover for the buy the dip strategy to return… least for a short while.

US Stocks Recover, but Only in Part

February 20, 2018

After suffering the first correction in two years, the S&P500 roared back with a huge 4.3% gain last week. Unfortunately volume on the upside was far lower than it was on the downside the prior two weeks. This means that investors did not run back into the US stock markets buying equities with both hands; if anything, last week’s bounce was driven by short-covering. Volatility did come way down last week; the VIX index dropped off into the upper teens. Unfortunately, once again, this is still a level that’s far more elevated (almost double) than the levels enjoyed during most of 2017.

What’s interesting about last week’s bounce, and what supports the theory that short-covering drove most of it, was the fact that the inflation figures reported during the week were far worse (ie. higher) than experts had anticipated. Normally, this would have set off even more selling—on the theory that higher than expected inflation will lead the Federal Reserve to raise rates faster than planned. Instead, US equity markets shook off the shockingly bad CPI and PPI misses and rallied. In other US macro news, retail sales missed badly. The Empire State manufacturing survey disappointed. Industrial production fell, when it was supposed to rise. On the bright side, the Philly Fed survey, housing starts and consumer sentiment all beat expectations.

So the bottom line on this recovery is that it’s returned less than half the losses that US equity investors have suffered. And what happens next really all boils down to investor sentiment (because even with a 10%+ correction, equity market valuations have not really changed all that much—they’re still extremely high). If the “buy-the-dip” mentality is still intact, then the bounce may continue and return the major indices back to their all-time highs…..and beyond. But if the “buy-the-dip” mentality has weakened, then many investors will be looking for significant bounce as their cue to get out, before another more severe correction (or worse, a bear market) begins. In this case, a new “sell the rallies” mentality will take over, and the stock market would promptly move below—and stay below—the 200 day moving average. We’ll know which way the market sentiment has changed, or not changed, in less than two weeks.

US Stocks Suffer a Correction

February 12, 2018

After suffering the biggest loss in two years the prior week, the S&P500 registered another, this time even larger, loss last week. Dropping 5.2% by Friday’s close, the S&P500 officially entered a “correction” which means it’s lost more than 10% from the peak. The last time this happened was in early 2016, almost exactly two years ago. While volatility rose again last week, by Friday’s close, the VIX index had backed away from its intra-week highs. And trading volume surged, as some investors actually rushed to sell and get out of the stock markets.

All that said, let’s remember that a 10% loss, so far, is really not a huge deal, especially given the parabolic move upward that the S&P has enjoyed over the prior 3-4 months.

From a technical analysis perspective, the S&P’s drop magically stopped just at the 200 day moving average, which most technicians would agree is always a strong support level. The question now is whether the S&P will bounce all the way back up to its highs, or will it re-test and break below its lows…..near the 200 day moving average.

This test will happen soon. Since most of the market has been conditioned to “buy the dips”, for this buying pattern and buying psychology to continue, it must work to regain the old highs over the next several days.  If not, then the 10% peak-to-trough loss will almost certainly cause a huge percentage of investors and traders to change their trading strategy—from buying the dips to selling the rallies. And if this happens then there will be very little to support the S&P500 until a far larger loss is incurred.

As described a few weeks ago, this is why parabolic moves upward do not correct with a sideways pattern; instead they correct with sharp drops. After large parabolic moves higher, value buyers—or potential stock buyers who would be willing to step in and catch falling knives—will naturally require far larger percentage drops in stock prices to justify the risk from buying falling knives. If value buyers enter too soon, they will risk buying at prices that are too high and will therefore suffer losses until the stocks they just bought find a more stable bottom. So they will not buy unless prices fall a lot more than 10-15%.

So this upcoming week will be critical to determining which way the S&P moves—back up or back down. One thing is almost certainly not going to happen—the S&P500 will probably not remain in a super narrow trading band.

And with the suppressed volatility regime now over (VIX has exploded upward over the last two weeks), we should expect to see another bumpy ride for the S&P, regardless of which direction it ultimately moves to—back up or back down.

US Stock Markets Drop Most in Two Years

February 5, 2018

Finally, a break from the seemingly endless melt-up in US stocks. Last week the S&P500 lost almost 4 percent, which makes it the biggest weekly loss since 2016. Volume jumped up a bit—not a huge amount, but to levels higher than those seen during weeks when prices rose. And volatility really jumped. The VIX index moved into the mid-teens, again a level not seen since 2016.

What happened?  Well aside from the fact that the US stock markets were a disaster waiting to happen (ie. valuations were stretched to levels last seen only in 1929 and in 2000), a couple of catalysts sparked the selling. The first was the continued climb higher in US Treasury rates. The 10 year, for example, climbed well in the 2.8% range by Friday. And this sudden jump in rates, spooked equity investors. The other catalyst was the jobs report, and specifically the average hourly earnings percent, which came in higher than expected.  The problem here is that if investors see larger gains in wage increases, that means inflation is becoming a greater threat and corporate earnings will be pressured.

So how big a deal is this?  Even though the Dow Jones Industrial Average fell 666 on Friday alone, this is not—at least not yet—a very big deal.  Why?  It all has to do with percentages. Friday’s loss, as large as it was terms of points, represented only a couple of percentage points in losses.  Sure that’s not good, but by no means is this some sort of crash. For that to happen—a crash—we’d have to register a weekly loss in excess of 10% and a drop of well over 20% from the all-time highs.

As of Friday’s close, the S&P500 was off only about 4% from its all time highs …. nothing even remotely close to a crash.

That said, when parabolic moves upward take place—the way they have over the last few months—corrections to such moves do not come from sideways corrections. They almost always come from sharp and severe reversals.

So this large weekly loss must be reversed, immediately, next week for the melt-up to continue. If not, and another sharp loss occurs next week, then we could finally witness the beginning of a correction, something we haven’t seen in the S&P for several years now.