In a shocking….and then again, not so shocking….development, the S&P500 collapsed by over 7% last week, bringing the current peak-to-trough loss up to about 18%. This was shocking, because the S&P500 had already been deeply oversold, and over the last 9 years, similar conditions have been followed by meaningful bounces….even if markets continued to sell off more, as they did in late 2011 and early 2016. This time, no dip buyers appeared. On the other hand, this was not so shocking because as we noted last week, BEFORE the 7+% crash:
“….from the perspective of technical analysis, it looks like the bears have taken control of the US equity markets….”
For those who are looking for signs of any short-term bottom, the signal from volume is disappointing. Volumes remained subdued last week. This means that we have YET to see the stampede for the exits, a stampede that accompanies almost every tradable bottom. Adding to this argument is the subdued VIX index reading; yes, it has jumped up to about 30, but that’s nowhere near the levels reached during prior panic dumps….levels closer to 40 or even 50. So on these two metrics alone, there’s probably more near-term selling directly ahead.
Interestingly, there was no shockingly bad economic news to trigger last week’s collapse. Sure the Empire State manufacturing index disappointed, as did the housing market index, durable goods orders (both headline and ex-autos), and personal income. However housing starts, existing home sales, initial jobless claims, leading indicators and personal spending all beat their respective estimates.
As discussed here over and over again, the US equity markets did not plunge because of any one specific factor. Instead, they fell–and may continue to fall–for two fundamental reasons:
1. Valuations reached insanely high levels, thanks in large part to the excessively easy monetary policy from the Federal Reserve
2. Prices start falling when investors’ psychology–for whatever reason–changes from optimism (when they buy the dips) to pessimism (when they sell the rallies)
For the last three to four years, valuations had already reached, by historical standards, extremely high valuations. But that fact alone did not lead to a bear market in US stocks. But for the first time since the market bottom in 2009, investor psychology looks like it has finally changed, to one of pessimism.
And the worst part about this change in investor psychology is this: when it happens, it typically lasts for well more than one year, sometimes approaching two years. And because the peak in US stock market prices was reached in the first couple of days in October, only three months ago, many more months of selling may still lie ahead.
All that said, our Simple Rule has not yet turned bearish. For this to happen, several key economic indicators will have to turn south. And as of now, this has yet to happen. In about a week or so, when the US jobs report is announced, we will look to see if any of these indicators has turned down.
Until then, we remain cautiously bullish—not adding any meaningful long positions, and looking for signals that would cause us to jump almost entirely out of the US stock markets.