S&P 500 Now Oversold

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.

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