On July 2nd, when the S&P500 (SPX) was still comfortable in its then 5 month trading range between 2050 and 2130, I wrote a post titled Don’t forget what you are celebrating as the pre-market futures caught a bid after weaker than expected June jobs data:
With the market still near all time highs you should only be buying stocks or equity index etfs/futures because you believe the U.S. economy and corporate profits will soon break out from the slow growth that we’ve seen throughout most of the recovery. If you are buying because you think you have a few extra months of ZIRP, then you aren’t really investing, you’re playing musical chairs and assuming you’ll find a seat when the music stops. It’s entirely possible the Fed is unable to exit ZIRP at a perceived opportune time, and will have to do so in a mediocre economy. If those are the conditions you want to be in while committing new capital to stocks near highs, then good luck with that.
Riding the Fed’s coattails is getting a little long in the tooth. This is kind of evident with the equity returns we’ve seen year to date. Don’t Fight the Fedworks both ways. Everyone knows it’s coming, a few extra months no longer matter. For stocks to go higher from here we need to see good economic data. Really good.
When buying stocks on bad economic data points because of the Fed, don’t forget what you are celebrating.
Prior to last week’s breakdown below, these sorts of counter-intuitive rallies were explained away as merely FOMO (fear of missing out) combined with and underlying bullish pre-disposition towards the equity market. But the real operating principle among investors was that good news for the U.S. economy was good news for U.S. stocks, and that bad news for the U.S. economy was also good news for U.S. stocks as the Fed would not act to tighten monetary policy. This psychology established a very well defined range had been in place since February.
But here we are a few weeks away from a possible Fed liftoff from ZIRP after 7 years, and external factors have made the investment landscape a lot more challenging.
I obviously have no clue if the sharp decline in U.S. stocks starting late last week was the buying opportunity of the last 5 years, but I will tell you that the sort of selling just witnessed, and the subsequent bounce back is anything but healthy at this stage of the bull market. It’s extremely unlikely that the one week 11% rout was it, and now we are back again off to the races. I am not saying its impossible for a new high in 2015, I am saying it is VERY unlikely. I am not saying that the U.S. stock market is going to crash from these levels, but I am saying that it is VERY likely that we test the lows from earlier this week.
The selloff means we now have another range to trade against. Just as we did from February to last week,only this time the volatility bands are massively wider. Prior support now becomes technical resistance at 2050 (red line) and the prior low of 1865ish should be I spot to shoot for on the downside. If it goes through there all bets are off:
We’ve just experienced a long period of low volatility in US equities that ignored pick ups in volatility in almost every other asset class around the world. The pick up in volatility means cheers for this rally from the lows could quikcly turn to jeers. Regular readers know that we used the sell off to scale out of short positions (read here). Yesterday, with the QQQ (read here), we began to lay out shorts at technical resistance as we feel the bounce could run out of steam. On the flip side we’ll use the bottom part of the new range as the preferred area to establish longs.