S&P500 Stalls…and Retreats

March 25, 2019

After advancing earlier in the week, the S&P500 had a very bad day on Friday (on which it lost 2%) to close the week down almost 0.8%. Volume was light, and volatility spiked into the mid-teens. That said, a mid-teen reading on the VIX is still not a level associated with panics.

Interestingly there was no big piece of news that drove the late week sell-off. In fact, several economic reports surprised to the upside—factory orders, initial jobless claims, the Philly Fed survey, leading indicators and existing home sales all beat their respective estimates. Only the housing market index, and PMI composite flash disappointed. So in many ways, the US economic picture brightened a bit last week.

On the technical front, the S&P500 has still not returned to old highs set in early October 2018. And last week’s decline….somewhat close to the prior level of resistance at 2,800….suggests that this technical resistance has yet to be broken. The 200 day moving average is now essentially flat, and prices are only slightly above this critical marker. So it’s far from clear, technically, where this market is headed next….especially over the next several days and weeks.

One of the major drivers of last week’s sell off was, ironically, the recent dovish u-turn made by the Federal Reserve. After a couple of years of tightening, the recent decisions to scrap further increases in the Fed Funds rate and to stop the balance sheet wind down later this year both suggest that the Fed is now worried that it may have over-tightened and that a recession is more likely to arrive in the near future.

The US stock markets, picking up on this interpretation, may be starting to sell off in anticipation of this recession and the consequent reduction in corporate earnings.

Sure there are other plausible explanations, but this one was getting a lot of press after Friday’s big sell-off. Let’s see what the next week or two brings to the S&P500.

Our Simple Rule Flips Again — Back to Bullish

March 18, 2019

Amazingly, the S&P500 roared back up last week, this time by almost 2.9%. Volume was light however; this suggests once again that the sudden spike in prices did not occur as a result of a big inrush of investor capital. According to many market experts, short-covering and the steady stream of corporate buyback activity pushed the large cap market higher. At the same time, volatility did climb down; the VIX index fell all the way back to a 12 handle.

So what happened with the US economy during the big move upward in stock prices? Ironically, the majority of the data released last week was a disappointment. Retail sales absolutely collapsed in December (report delayed due to the government shutdown), even though sales did inch higher in January. Durable goods orders, ex-transportation, also missed badly. New home sales, jobless claims, the Empire State manufacturing index, and industrial production all missed as well. On the positive side, construction spending, consumer sentiment, and the JOLTS survey beat their respective estimates. So the stock market rally had very little to do with good news from the economy, which continues to limp along.

Also, in the background, the Federal Reserve balance sheet continues to shrink at roughly a $50 billion per month rate. As of last week, the Fed’s balance sheet has fallen by almost $500 billion from peak. Clearly, this balance sheet reduction is also not contributing to the recent jump in US equity prices.

Finally, our Simple Rule—due to the sudden surge in equity prices—has flipped back to being bullish. While the fundamental components of our rule are bearish, the technical, and in this case, deciding, components are implying that investors should — for now — go long the S&P500 stock index.

Our Simple Rule Goes Bullish but only Temporarily

March 11, 2019

Last week, and for the first time in all of 2019, the S&P500 gave back a material amount of gains. The index closed down almost 2.2%. Volume was light, so there was no rush for the exits. But volatility jumped: the VIX index moved from about 13 to about 16, after temporarily moving above 18.

Once again, the S&P failed to break above—and stay above–the 2,800 level. Something similar happened in both November and December 2018. This is concerning because for the bulls to successfully argue that the bull market is still in effect, not only does this 2,800 level need to be reclaimed, but the index must advance back to the old highs (close to 2,950) set October 2018 and then set new highs. But now that investors have tried—and failed—to do this three times over the last six months, many experts are getting concerned, and rightfully so, that further gains are limited. What’s worse: the argument that the all-time highs, in this bull market cycle, are behind us becomes stronger.

On Friday February 19th, our Simple Rule, interestingly, changed from being bearish back to being bullish. Keeping in mind that our rule has two major parts, a fundamental part and a technical part, it’s important to note that the fundamental part of the rule did not flip from being bearish to bullish; instead it remained bearish. What changed on February 19th was the technical component, which flipped to bullish on February 19.  And based on the way the Simple Rule is designed, this conflicting set of signals is resolved in favor of the technical component, meaning that the overall signal became bullish again.

But as of Friday, March 8—after the material loss in the S&P500—the technical component of our Simple Rule flipped back to being bearish. So now, combined with the unchanged bearish fundamental signal, our overall signal returned to being bearish.

Given that our Simple Rule is extremely slow moving, this whiplash is very unusual. So let’s see how the US equity markets behave over the next several weeks; specifically, let’s see if they act in accordance with our signal.