Santa Claus Rally Ends?

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.


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