S&P 500 Now Oversold

November 26, 2018

In another scary week this year, the S&P500 dropped almost 4%. This is the third time this fall alone that the large cap index has lost about 4%. Volume was light, but this had more to do with the Thanksgiving holiday than it did with investor sentiment. S&P volatility jumped (the VIX index moved into the low 20’s), but it has not exceeded the levels reached during the other two bad weeks in October (when the VIX reached the upper 20’s).

Also due to the holiday week, the number of US economic reports released was low. The US housing market index missed expectations; so did US housing starts. Durable goods, both headline and ex-autos missed badly. Initial jobless claims were worse than expected. Consumer sentiment also missed. Only existing home sales beat expectations. Also, the Federal Reserve’s balance sheet fell by 40 billion dollars, which is one of the largest weekly reductions in 2018. And since quantitative tightening started in October 2017, the Fed’s balance sheet has fallen by a total of 354 billion dollars…..a material amount, given that the balance sheet peaked at about 4.5 trillion dollars.

The technical picture of the S&P500 has become very interesting. On the one hand, the S&P is a complete mess….at least for bulls….on both the daily and the weekly charts. Not only have prices crashed below both the 50 day and the 200 day moving averages, but the 200 day moving average is now sloping downwards. And barring some massive surge in the S&P over the next two weeks, it’s very likely that the 50 day moving average will cross below the 200 day moving average over these next two weeks. This will create a “Death Cross”, a very bearish technical signal, one that we haven’t seen since 2015.

On the other hand, the S&P500 is now deeply oversold. And from these oversold conditions, it’s common to see a meaningful bounce. The bulls can also point out that the lows from last week have not taken out the lows from October, or the lows from February and April….earlier this year. And unless these lows are taken out, traders can use today’s low prices as entry points to bet on a bounce. And supporting the bulls, our Simple Rule has also not turned bearish. The US economy, as uninspiring as it’s been, has not shown clear signs that suggest it’s entering….or about to enter….a recession. And until this happens, our rule will stay bullish.

So let’s see if today’s oversold conditions lead to a bounce over the next few weeks. The seasonal factors—end of November and early December—also raise the likelihood of this bounce. On the other hand, if it doesn’t happen, and the S&P 500 takes out all the lows of 2018, then the probability of entering a bear market, for the first time in nine years, will rise substantially.

US Corporate Bond Spreads Widening…..Finally

November 19, 2018

Last week the S&P500’s bounce came to an abrupt end. The large cap index gave back 1.6%, on moderate volume. Volatility did jump on the worst sell of days, but it did come back down on Friday when prices recovered a bit.

As usual, US economic reports were mixed. Consumer prices came in exactly as expected—up slightly from last month’s reading. The same thing happened with core consumer prices. Retail sales beat consensus estimates. So did the Empire State manufacturing survey. On the downside, initial jobless claims were slightly worse that expected. Industrial production also missed expectations….as did the Philly Fed business outlook survey. More importantly, on a year over year basis, several key US economic indicators are still showing growth. This means that our Simple Rule has not yet switched away from being bullish, long-term, the S&P500 index.

On a shorter term basis, the daily charts of the S&P500 are now somewhat murky—they are not strongly bullish or bearish. We’ll need another week of actual results to make a more definitive call. On the weekly charts, charts that provide a medium-term outlook, the forecast for the S&P500 is still somewhat bearish. The damage from October is still far from being repaired. This suggests that the usual seasonal Santa Claus rally through the end of the year may be in jeopardy or may not be as pronounced as it has been in prior years.

Finally, something interesting has just started to happen in the US corporate bond markets. When the S&P500 first corrected in late January and early February, US corporate bond prices barely budged. In fact, these bond prices not only held strong throughout the equity sell-off, they actually rallied into the summer months. And even when the US equity markets took another dive in early October, just last month, US corporate bond prices held firm.

Until now.

Over the last two weeks, the high yield spread has widened out to its highest level in almost two years. The same has occurred with the investment grade bond market. With high yield bond prices especially, there tends to be a strong positive correlation with US equity prices. And for much of the year, this correlation broke down. But now that corporate bond prices are beginning to sell off, the concern is that the corporate bond market is validating the weakness in the US stock market. And unfortunately, this does not bode well for future US stock market prices. Now that both markets are getting into sync with each other, US stock market investors and traders will be more likely to sell down their stock market exposure even further….leading to additional price drops in the US stock markets, at least in the short to medium term.

The S&P’s Bounce Continues

November 13, 2018

For the second week in a row, the S&P500 gained ground in an attempt to repair at least some of the massive damage suffered in October. This time the S&P rose 2.1%. But once again, volume was light so this gain had as much to do with short covering as it did with money returning to the US stock markets. That said, volatility dropped off, which is an encouraging sign because equity prices rarely continue to climb higher when the VIX index rises.

As usual, the US economic reports were mixed. ISM services and consumer sentiment both beat expectations. On the other hand, the JOLTS survey, consumer credit, and initial jobless claims all disappointed. One of the most surprising results was the producer price index for October—both headline and core prices surged way past consensus expectations. This hurts the US economy because producers will either have to raise prices to their customers (ie. US consumers) or they will eat the cost increase which will hurt corporate profits. So all eyes will be on the consumer price report which comes out later this week.

In terms of technical analysis, the two week rally has helped repair some of the damage on the daily charts. Prices have climbed back above the 200 day moving average. The next challenge will be to reach the 50 day moving average. On the other hand, the massive damage from October has now turned the slope of the 200 day moving average down. This will put a lot of technical traders on the defensive, as they look for evidence that market players begin to sell the rallies, instead of buying the dips—as they have for many years now. Also still bullish is the fact that the 50 day moving average is above the 200 day moving average. In other words, a death cross has not occurred. And while the weekly charts are still showing the ugly damage from the October sell-off, our Simple Rule…..as of last week….is still bullish.  However, this upcoming week’s economic reports may easily reverse this signal.

So as of now, we remain cautiously constructive on the S&P500 index as a whole.

S&P Rebounds

November 5, 2018

Even though the month of October was one of the worst for the S&P500 since the great recession, the S&P closed last week with a 2.4% gain. Volume during this up week was lower than it was in the previous week when prices fell substantially. This is not a good sign for bulls because it suggests that last week’s rise was in part based on short covering, profitable short covering, not on new money being put to work at depressed prices. Volatility, on the other hand, dropped off materially; this is a good sign for the bulls because it paves the way for investors who can add equity risk but only if the VIX shows signs of backing down, which it did last week.

In US macro news, personal income missed; so did the Case Shiller home price index. Chicago PMI also missed. And in one bad day (Thursday) alone, all six reports missed–the Challenger job cut report, initial jobless claims, productivity, PMI manufacturing, ISM manufacturing, and construction spending. But much of this bad news was eclipsed by the relatively strong October jobs report which recorded 250 thousand new jobs vs. the 190 thousand expected. Also in this report, we saw that average hourly earnings rose, on a year-over-year basis, faster than it had in several years—3.1%. The only downside to all the good news in the payrolls report is that it will force the Federal Reserve to raise interest rates more aggressively, to make sure that wage inflation doesn’t get out of hand; this could lead to general consumer inflation, which per the mandates of the Fed, must be strictly controlled. And this upward pressure on interest rates will put a brake on the bullish action in the US stock markets.

In terms of technical analysis, the S&P’s bounce now shows up as a bullish signal on the daily charts. This means that it’s very likely that traders will want to catch the continuation of this rebound, especially as the seasonally favorable end-of-the-year dynamics kick in (stocks tend to rally, on average in the last 45-60 days of every year). On the weekly charts, however, the technical damage from October was too severe to be fixed by one moderately strong week. So the weekly charts are still pointing to the probability of more selling in the intermediate term.

All that said, our Simple Rule is still bullish. Interestingly however, the technical component of our Simple Rule has flipped to being bearish. But until the fundamental economic component flips to being bearish—and through last Friday’s economic reports, it’s still showing that the US economy is expanding—the Simple Rule ignores the bearish technical signal…..and remains bullish on the S&P500 index.