S&P 500 may hit 1,000 before it makes a new high

Deflation is in the air. It’s gutting the prices of raw materials, emerging markets, junk bonds and starting to catch up to equities.

It’s going to get ugly

The journey up was fast and fortuitous, without the structural economic improvements that should accompany such a prolific bull market.  And more importantly, with enormous leverage and speculation driving prices.

The mini-panic on August 24, 2015 showed us that the market is capable of wild swings, and likely enormous drops.  In 2008 we saw the stock market lose more than a quarter of its value in days.  This sort of action is not only likely, but I expect it.

Why 1,000? 

This level puts the index back to major area of psychological support and also seems to complete what may be a head and shoulders pattern forming on the S&P 500 back to the base of the left shoulder.

1,000 is a level where the market was before the latter incarnations of QE wildly distorted prices higher. I believe that the beneficial effects of QE were overestimated and that the detrimental effects underestimated.

The gross distortion of prices has destroyed many price signal indicators.Adding to that the lack of interest bearing savings account has forced savers to speculate, hoping for a gain.

spx

Buyback backtrack?

The stock market’s valuation has largely benefited from corporate buybacks.  Now corporations possess an enormous amount of debt.

Additionally, corporations tend to get cold feet as the market is volatile or when prices decline quarter over quarter.  That means less buybacks should occur as fear overtakes greed.

Have some cash set aside

Right now my own inclination is to make a wish list of stocks to own and an idea of what prices make sense to buy them.  Then wait for prices to come to me.

Rather than chasing prices or settling for buying something that may be overvalued I think it makes sense to set cash aside and buy in at lower prices.  In all likelihood they are coming soon.

Trend support broken on S&P 500 index

Stocks are selling off — and fast.  But what exactly is a price trend and what do they look like?  Trends are defined as a series of higher highs and higher lows for an uptrend and a series of lower lows and lower highs for a downtrend. Uptrends are the result of more buying than selling for a given period of time while the inverse is true of downtrends.  An uptrend is essentially a chart where the price starts on the lower left and ends on the upper right.

After the S&P 500 consolidated for about a year it has decidedly turned much lower — and quickly.  With the worst three point day rout in the Dow since its inception behind us now, what is going to happen next?

First, I think it’s important to note that while I believe the trend remains down, there is likely some sort of bounce that will come soon.  Think of it as a moderating bounce.  One where we see some positive price action to push things off the extreme lows and encourage some buying.  After all, across just about every measure on the short to intermediate term, stocks are oversold.

damagedWe’re overdue for a bounce, but what follows may be a trounce.

That being said, it’s most likely that such a wave of buying will be short lived and followed by additional, deeper selling.  The reason I believe that this is the case is that the main catalysts that have driven the market higher, as discussed in my previous article, are largely drying up.  While at the same time, the global picture seems to be much more grim.

Crude head fake means lower prices ahead likely

Crude oil has had quite a slide since July of 2014.  Recently it appeared as though prices may be stabilizing, but recent price action may suggest that what seemed to be a double bottom may actually have lead to a head fake rally rather than a durable price support level.

crude oil pricing

US crude oil spot price chart from the last 6 months.

With a firm rejection at the 50 day moving average, and the bollinger bands widening, it seems that on a technical basis crude is poised to take out its lows.  Is a $30 even $20 in the cards?  Possibly.  Crude traded as low as the mid $30s back in early 2009.  We could see similar price action in a capitulation event or a slow grind down.  There is not enough conviction for a significant price breakout without increased demand or a geopolitical event threatening oil production.

 

Higher stock market volatility may be persistent in 2015

A recurring theme in the bull market rally since 2012 has been minimal volatility.  The days of enormous whipsaws in price were seemingly behind us until late 2014.  The mood of the market has decidedly changed as of late.  What used to be a complacent, calm and somewhat orderly march in to parabolic territory has degenerated in to a much more unpredictable series of widening trading ranges.

Watch for a potential trend change

As volatility increases, there is the potential that fear will overwhelm greed and the bulls will become more concerned about securing profits than taking risk.  Margin levels are off the chart and short positioning is still historically low, so downside momentum may hasten quickly if it is perceived that an interim top is forming.

Volatility index (VIX)

If such a change occurs, it is likely that we will see a long overdue correction occur in the broader equity and lower tier credit markets.  It also may prompt an exit from the crowded long dollar trade if the risks are perceived to be domestic.  2015 holds plenty of promise for interesting global and financial market developments.  Stay close to the news feed and price ticker.

Caution! Market crash could be imminent

With growing uncertainty surrounding the European debt crisis, and the contagion spreading to much larger sovereigns, such as Italy, we now see risk aversion back on the table.  US markets are down over 3%, the headlines seem to be getting progressively worse and many fear that the situation could deteriorate much further — giving up much of the gains achieved in October.

Growing concern as market whipsaws

This kind of volatility, both up and down, is historically an indicator of very large market moves.  With the bias largely negative, it seems that a market crash could be coming if no resolution is found for the EU debt implosion.  Alternatively, should a large scale bailout ($2T+) occur, we could see a significant rally, especially within precious metals spot prices and miners.

For investors and traders, this type of price action is stressful.  Seeing fluctuations of multiple percentage points in indices and nearly 10% in stocks can cause forced position liquidation because of stop loss orders being triggered.  For traders, who generally capitalize on multi-day moves rather than moves within a single day, this type of action can cause significant losses should one be caught on the wrong side of the market action.  High frequency trading machines may capture gains, but are not providing liquidity or improving market efficiency, especially during periods of intense market moves.  Instead, evidence seems to be growing that the machine-based traders are making the market less stable and more prone to large price swings.

World view deteriorates

Global markets plunged as well, with Italy down over 9%, Poland down nearly 9%, Germany down over 7% and other European markets leading weakness as stock prices bleed, especially within the financial sector.  The lackadaisical response out of the EU, ECB and IMF leadership seems to be draining confidence and sparking fear in the markets.

US banks have hundreds of billions of dollars worth of exposure to European sovereign debt, banks and other related instruments.  Many have written credit default swaps, a form of insurance that has no capital reserve (see AIG implosion circa 2008) against European debt, exposing them to significant risks should the EU situation worsen.

Broken bonds from backwards economies

Many Western countries now face the prospect of sovereign debt problems, as their economies continue to slow, while investors fear that they will not be able to pay back the debt.  The United States is no exception, as its official debt reaches 100% of GDP, and by some estimates, their total outstanding unfunded liabilities have reached $75 trillion.

Japan has a 200% debt-to-GDP ratio, which is only made possible by the fact that most of their debt is held by Japanese banks and pensioners, but the situation there is deteriorating with growing political and economic instability.  Even China is no exception, as their economy is slowing down and the yield curve on Chinese debt has inverted for the first time — causing serious concern for those that felt China would lead the world out of recession.

The coming crisis

What happens next is not clear, but what is evident is that the world is changing.  Slowing economic growth, the bursting of the largest credit bubble in history, significant deterioration in debt-driven consumption and resource depletion all leads to a potential crisis.  All of the new debt that has been created to attempt to stem the last debt crisis has only exacerbated the underlying structural economic problems we are facing.  Papering over large amounts of fraud within the financial system and ignoring the peril of main street has divided the Western world.  Growing civil unrest and lack of available employment, especially for the young, has created the potential for large scale disruptions (think of the “Occupy” movement, but on a global scale with a significant percentage of the population participating).

I feel that unless we start seeing accountability within the financial sector and governments of the world, prosecution of the enormous fraud, transparency within the political and electoral process and erosion of corporate personhood in so far as money is considered free speech, as well as more regulation of over the counter derivatives, we will look back at the 2008 crisis and think of it as a relatively calm and orderly time within the financial markets compared to what could happen next.

S&P 500 uptrend intact for now

The S&P 500’s uptrend remains intact in a defined channel that found support today, during the stock market sell-off, at the 20 day moving average. The chart below shows the trend channel as well as the moving averages.

S&P 500 chart

Uptrend channel intact

There are some technical issues at play here, however, that we cannot discount. First and foremost, as I mentioned in the previous post there is a double top pattern in the S&P 500 that is playing out and causing a decent amount of fear. Combine that with Chinese inflation worries that toppled the Shanghai index down over 5% last night and we find the markets climbing a wall of worries in to the weekend. Most commodities took extreme hits today, with sugar, silver, palladium, gold, cotton and various grains falling off their highs. Oddly enough the dollar was weak while all this selling in commodities and equities was taking place, which is contrary to what we’ve seen in the past months.

Seasonally this time of year tends to be rather positive for equities. The holiday season usually gives earnings and employment a boost and consumer sentiment usually picks up — except for what we witnessed in 2008 of course. Next week should shed more light on the technicals and fundamentals of these markets. As we see trading begin in Asia it will be interesting to see if the appetite for precious metals is once again renewed as it was after the silver sell off on Tuesday after the CFTC raised margin requirements by 20% (from 5% to 6%).