Our Simple Rule Flips Again — Back to Bullish

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.

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