US Stock Markets Crash

December 24, 2018

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.


When Will US Equity Investors Start to Panic?

December 17, 2018

The S&P500 lost another 2% last week. This loss comes on the heels of a stunning 4.6% loss the previous week. Contrary to expectations, the S&P volatility inched down–the VIX index closed the week close to 21 (vs 23 the week before). And trading volume, while not light, did not explode higher. In other words, investors did not run for the exits.

Interestingly, there was no extraordinary US economic report that investors could point to as the trigger for this latest sell-off. The JOLTS survey was stronger than expected. Producer prices came in a bit hotter than the consensus estimates. Consumer prices, on the other hand, come in just as economists predicted. Initial jobless claims were better than expected. Headline retail sales and industrial production also both beat their respective estimates. On the downside, US export prices were weaker than predicted. And the PMI flash composite also missed.

More importantly, several key longer term (year over year) measures of the US economy continued to show positive growth. In other words, as of the end of November, there was no clear signal that the US economy had entered into….or was about to enter into….a recession. And because of this, our Simple Rule remains bullish on the S&P500 index.

Meanwhile, the technical picture of the S&P is now getting quite ugly. First, the Death Cross–as we noted last week–has now only grown stronger. The 50 day moving average has sliced below the 200 day moving average and it looks like it will continue to drop. The 200 day moving average itself has turned down–ie. its slope is now negative.  The closing price is now well below the 200 day moving average, and if a bear market cycle actually develops, one of the key technical points of this type of market is that prices generally rally up to the declining 200 day moving average (which now acts as resistance) and then fall back down…to set lower lows in this cycle. Note that this is the mirror image of buying on dips when a bull market reigns and the 200 day moving average slopes upwards. Next, the longer term weekly charts are now giving a much more bearish signal. The weekly MACD lines have crossed into negative territory, for the first time since 2015. RSI had diverged from the price of the S&P500—when the S&P set new highs in early October, the RSI came nowhere near the highs it set in January—and now this bearish divergence looks like it was quite accurate. The S&P500 has now fallen by more than 10% from peak, meaning the S&P has entered correction territory. And finally, the super important monthly charts are also quite bearish now. Many key monthly moving averages have experienced their own death crosses.

So from the perspective of technical analysis, it looks like the bears have taken control of the US equity markets….at least for now.

But it’s important to note that investors have not shown any clear signs of panic. As mentioned above, volumes have not exploded higher and volatility has also not skyrocketed. So for bulls who want to find some sort of bottom in this correction, they will look for a capitulation sell-off, when volumes and volatility explode to the upside. And this has certainly not happened yet.

Santa Claus Rally Ends?

December 10, 2018

Shockingly, after jumping 4.8% the previous week, the S&P500 registered a 4.6% loss last week. This represented one of the worst losses of the entire year. Still, despite the big loss, volumes did not explode higher; this suggests that investors and traders were not selling out of panic. This also suggests that the lows of this recent sell-off have not yet been hit, because most major lows are accompanied by panic drops, where volume spikes. What also typically spikes at major lows is volatility. And while the VIX index did rise to about 23, it’s still a long way away from the highs associated with major stock market index lows; this would usually be well in excess of 30.

There was no single clear-cut economic trigger to last week’s collapse in US stock prices. Sure the November payrolls report disappointed (only 155,000 new jobs vs the 190,000 expected), but this was by itself not a disastrous report. In fact, none of the US economic reports were disastrous—ISM manufacturing beat consensus estimates, so did PMI services as well as ISM services. Consumer sentiment and consumer credit also beat their respective estimates. On the downside, construction spending missed, so did international trade and initial jobless claims. Within the jobs report, average hourly earnings (on a month to month basis) also missed. And the average workweek came in light. But the headline unemployment rate came it at a stable—and extremely strong—3.7%.  So all in all, last week’s US economic picture didn’t change much from that of the prior week, when the US stock markets soared.

What did change, for whatever reason, was investor sentiment. Suddenly, many investors decided that they wanted to de-risk, not necessarily in a panic “sell everything” manner, but in a more orderly “let’s reduce risk but selling some stocks” manner. In terms of technical analysis, several key factors now come into play. First, with last week’s drop, the 50 day moving average has crossed below the 200 day moving average. In the technical world of investing, this is known as the “Death Cross” and more often than not, when it happens, more selling follows. The second big factor was the low point of the sell of last week. For the first time this year, a low point was lower than the preceding low point during previous sell-offs. All previous big lows this year were higher than the preceding lows. This is another bearish development that will cause technical traders to turn more bearish on the S&P500.  Third, by finishing the week so far below the 200 day moving average, this moving average has once again returned to sloping downwards; the 200 dma may now act as overhead resistance as the S&P500 trades beneath it.

On two other important fronts, the news is mixed. The Fed’s balance sheet is now shrinking by precisely $50 billion each month, or at a rate of $600 billion annually. This is a significant monetary headwind to rising stock prices, a headwind that does not get the media attention that rising Fed Funds rates usually do. So even if the Fed decides to slow down, or even pause, it rate hiking campaign, the quantitative tightening may continue unabated for a longer time….and this process acts in a way that is similar to hiking rates: it puts monetary brakes on the economy and this usually translates to lower stock prices. Finally, on the bright side, our Simple Rule is still bullish. Despite the recent struggles of the US stock markets, the US economy has not produced clear cut signals that it’s entering….or about to enter….a recession. And until this happens, extensive research has shown that it pays to remain long the S&P500 index.


The Santa Claus Rally Begins?

December 3, 2018

After losing a painful 4% the prior week, the S&P500 bounced back—actually roared back—with a 4.8% gain last week. Unfortunately, volume only inched higher; this implies that investors are not totally enthusiastic about the big price gain. And volatility, while it did drop down as expected, did not fall anywhere near the lows of the summer. The VIX index closed on Friday at a still somewhat elevated level of 18.07.

There were plenty of US economic reports last week, but none of these appeared to drive the US equity markets higher. Among the misses were the Dallas Fed manufacturing survey, the Case Shiller home price index, new home sales, the Richmond Fed manufacturing index, international trade in goods, initial jobless claims, and pending home sales. Among the positive surprises were the Chicago Fed national activity index, wholesale inventories, personal income and personal spending, as well as the Chicago PMI result. In other words, there was no huge change in trend with respect to the US economy, which continues to muddle along, with the recent tailwind from the Trump tax stimulus about to dissipate.

Technically, the S&P returned to its 200 day moving average. This is critical in terms of repairing the technical damage incurred since early October. For the bull case to grow stronger, now the S&P must rise above the 200 day and remain there. After that, the S&P’s next bullish target will be the 50 day moving average. A critical data point supporting the bullish case is the fact that the S&P’s lows, at each major sell-off during the year, have been higher than the preceding lows. A series of higher lows make the bearish argument difficult to accept, at least for now.

What drove the markets higher last week was political news and the expectation of a reprieve between the US and China in terms of their trade dispute. If the US does not go forward with slapping tariffs on virtually all of China’s imports into the US, the US equity markets should rally even further.

This sets up a positive scenario for risk assets heading into the close of 2018, when many market watchers were already expecting a favorable seasonal set up (the “Santa Claus Rally”) to push equity markets higher. If the US-China trade dispute continues to abate….at least for a short while….then the odds of this Santa Claus rally continuing for the next two to three weeks should increase dramatically.