US Stocks Suffer Another Big Drop

October 29, 2018

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.

US Stock Market: Good News and Bad News

October 22, 2018

The S&P500 closed the week essentially unchanged from the prior week, in which booked a notable loss, at least in percentage terms. Last week’s price action was still extremely volatile, with most days experiencing movements greater than 1%. While volatility, as measured by the VIX Index, inched down by Friday’s close, the VIX ended the week near 20, which represents one of the highest weekly closes of the year. Volume was moderate, which again suggests that most investors are not making major changes in their positions; in other words, investors did not pour new money into the S&P nor did they pull a lot of money out.

The week was busy in terms of US macro news. Month-over-month Retail sales missed badly—both the headline and the ex-autos figures disappointed. But at the same time, the year-over-year figure is still positive, and until this result turns negative, the US economy is very likely still growing. Industrial production beat expectations—both the monthly and the annual figures showed expansion. On the other hand, both housing starts and existing home sales missed; this looks to be the direct result of soaring interest rates and therefore soaring home mortgage rates. Finally, the Empire State manufacturing index and the Philly Fed business outlook both beat their respective estimates.

All in all, the US economy is not showing evidence that it has yet entered into a recession. Sure, the US is long overdue for an economic contraction, but as of now, it has yet to begin.

The technical picture is very mixed. The good news is that the 200 day moving average did it’s job—it provided the much needed form of support for the S&P500. While prices danced above and below this moving average over the last two weeks, by Friday’s close, the S&P settled just at this average. In other words, had prices ended the week notably below the 200 day moving average, a huge class of investors would have sound the bear market alarms and started to get out in much larger numbers. This didn’t happen.

The bad news is that the S&P did not bounce up from this same 200 day moving average, as it has over and over again for the last nine years. Sure it may still be too early to conclude that the bounce did not happen, but for this “buy-the-dip” strategy to work, prices must resume their climb this week, or by next week at the latest. If they don’t, then especially since everyone agrees that we’re in the very late stages of this market and economic cycle, many investors will start to head of the exits to prevent losing major profits that they’ve earned over the last nine years. And this of course would create a “doom loop” in which early selling would lead to further selling which in turn would lead to major market losses.

These next five to 10 trading days could determine the future of the current bull market.



US Equity Markets Tumble

October 15, 2018

For the second time this year, the S&P500 took a nosedive. It lost over 4%, and if it weren’t for a rally on Friday, it was on track for losing over 5% for the week. Volume jumped, as would be expected in a more significant risk-off week. And volatility exploded; the VIX index went as high as 29. That said, the VIX never reached the highs reached in February when hit exceeded 50. At least not yet.

Interestingly, there was no clear catalyst for last week’s market tumble. In US economic news, both consumer and producer prices came in LOWER than predicted; in other words, the inflation that many experts have been warning about has still not appeared. Initial jobless claims came in a bit higher than expected; but they’re still near multi-decade lows. And while consumer sentiment missed expectations, wholesale trade results beat expectations. So there was certainly no economic report that scared investors last week.

Many of the forces that had already been developing—eg. trade war tensions with China, higher US interest rates—got most of the blame. But again, these were not new stories that surprised US equity investors; they were all known, very well know, at the beginning of last week.

So some of the biggest culprits, according to experts, were program trading and short-term CTA trading, both of which triggered sell orders at the beginning of the week. And when US equity markets accelerated their declines, these trading strategies were forced to sell even more, into the drop, to reduce their respective risk levels.

All that said, the loss for the week was only 4%, which while meaningful, does not mean that the US equity markets have entered bear market territory (-20% from peak) or even correction territory (-10% from peak).

But what it does mean is this—will the US equity markets bounce back, from the 200 day moving averages that were touched last week, just as they have done for the last 8+ years when these averages have been hit?  Clearly, this upcoming week and the next will be critical to answering this question.

And this question is super important because as most everyone agrees, the US equity markets are in the late stages of their bull market cycle. So one of these days, a big sell-off like the one we saw last week will not provide the usual “buy-the-dip” opportunity for bulls. Instead, the markets will fail to bounce and finally—-finally—-enter their long awaited bear market cycle.

In the meantime, per our Simple Rule, the signal is still bullish: no US recessionary alarm has yet been tripped, and the long-term technical signal is still bullish.

A Couple of US Markets Offering Discounts

October 9, 2018

The S&P500 retreated another 0.97% last week. Volume was on the light side, so once again, there was no rush for the exits during this minor sell-off. That said, volatility did make a more notable move. The VIX index jumped from the low 11 range and temporarily rose to about 18. While 18 is still not a level associated with panics, this move in the VIX suggested that many traders were buying protection against potential losses in the future.

From a technical analysis perspective, the S&P500 is still extremely overbought, despite the recent weekly retreats. This is especially evident on the weekly resolution where the closing price is still far above the 200 day moving average. On the daily charts, the recent retreat brought prices close to the 50 day moving average. And since this moving average has provided a very consistent “buy the dip” signal over the last several years, there is a good chance that the S&P500 will be bought again, now that it’s dipped back down to the 50 day moving average.

The long-term indicators, for example the 200 day moving average and our Simple Rule, are still suggesting that the cyclical bull market is still very much in effect. So for the time being, the correct position is to remain net long the S&P500.

Meanwhile, there are two much smaller US securities markets that have suffered serious dislocations recently.  Both the baby bond market and the preferred market have incurred major price reductions over the last two weeks, primarily as a result of the rise in US Treasury rates.

Many preferreds and baby bonds, often rated investment grade (say BBB or higher), have fallen from average prices of around $26 per share to $22.50 per share. While it doesn’t sound like much, a 13.5% drop in price, over a span or 10 trading days, is a severe fall for these securities. The big opportunity, of course, is not the yield pick-up to be enjoyed by buying at the current depressed prices, but the anticipated one-time capital gains that would accrue as the prices returned to $26 from a starting point of $22.50.  Specifically, this would represent an 18% gain.

So while the S&P500 remains not that far off its recent all-time highs, and while both investment grade and high yield bonds remain near record tight spreads, there are some areas where investors—and granted this applies to smaller, non-institutional investors only, because these two niche markets are too small to accommodate institutional investors—can find some very attractive, and relatively safe, bargains today.


A Small Speed Bump in the Melt Up

October 1, 2018

Last week, the S&P500 gave back about 0.5%. Trading volume was on the light side, and volatility did not move higher in any meaningful way–the VIX index remained close to the lows reached earlier this year (August to be precise).

In US economic news, the week was mostly disappointing. Among the misses were the Chicago Fed national activity index, the Dallas Fed manufacturing survey, the Case-Shiller home price index, the FHFA house price index, new home sales, core durable goods orders, 2nd quarter GDP, international trade in goods, pending home sales, the Kansas City Fed manufacturing index, personal income, Chicago PMI and consumer sentiment. Only consumer confidence, the Richmond Fed manufacturing index, and headline durable goods orders beat their respective estimates.

Technical analysis is still showing the same message—the S&P 500’s uptrend has resumed, and last week’s slight decline was only a speed bump in this longer term uptrend. Of course, prices on the index are still overstretched to the upside, but this doesn’t seem to be preventing investors from bidding the index higher. And the mixed economic news also doesn’t seem to be a big problem.

As discussed over the last few weeks, until several critical US economic indicators turn down (these indicators were not impacted by last week’s mixed economic results), then the clearest pathway for the S&P500 is still upward.

Of course our Simple Rule captures this information and is giving us the same message—stay net long the S&P500 index, until further notice.