Surprisingly, the S&P500 did something it hasn’t done since late 2015—it failed to bounce off the 200 day moving average and resume its climb. In other words, the very consistently profitable “buy-the-dip” strategy failed to work. Instead, the S&P500 lost another 4 percentage points last week, making the month of October 2018 (so far) the worst in terms of percentage loss since October 2008. Countering this most recent sell-off was the message from volume and volatility. Both remained contained. In other words, neither one exploded higher as the week’s sell-off occurred; this suggests that investors have not sold out of the markets in any type of panic mode….as they almost always do in more severe bear market sell-offs. This doesn’t mean that volatility and volume will not jump higher in this most recent retreat….but as of yet, it hasn’t happened.
Interestingly, there was no clear catalyst that anyone could blame for the weekly drop in prices. The US macro news, while a little weaker than usual, was not so bad that it could be credibly labelled as the culprit. Sure the Chicago Fed national activity index, the Richmond Fed index, new home sales, durable goods orders ex-autos, international trade in goods, initial jobless claims, and consumer sentiment all missed their respective expectations. But at the same time, PMI composite flash, headline durable goods, pending home sales, and 3rd quarter GDP were all beats. So there was no earth-shattering report that spooked equity traders.
Instead, the US equity markets most likely sold off for a broad combination of reasons, starting with the fact that valuations are on the super high end of the historical range. The Fed has hinted that it will continue raising rates, despite this recent stock market weakness, and the Trump tax cut stimulus is about to wear off. Surely many other factors contributed. But it’s far from certain what was the one root cause, if any.
More importantly, the US stock markets are in a do-or-die condition right now. For the bull market cycle to have any hope of resuming, the S&P500 must reclaim its 200 day moving average over the next 1-2 weeks. If this doesn’t happen, the dominant investment strategy will flip to “sell-the-rips” where most bounces will be viewed by investors as opportunities to exit the stock markets. And if this psychology and strategy do take hold, then equity markets will continue to sell off and will build even more momentum to the down side. In other words, selling will lead to more selling.
Everyone does agree that the US stock markets are in the late stages of their expansion, so the question everyone is now asking is this—does this October’s sell off market the end of the 9+ year bull market cycle? We will need another few weeks to find out for sure.