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.