Is the Fed about to End the Party?

Is the Fed about to End the Party?

Six years and eight months into the US bull market, the S&P is bending, but not breaking. With the S&P futures stuck in a 7% trading range from -3.5% to +3.5%, the September e-mini (ESU15:CME) contract closed at 2093 yesterday, up 1.85% on the year. A slowdown in economic growth, and the Federal Reserve’s ‘threat’ to raise interest rates this year, has spooked investors. Over the course of the 6 year bull run it was easy to follow the money going into stocks by tracking the NYSE MOC orders (market on close orders). In most cases mutual funds put money to work on the first and last trading days of the month. They also buy stock in the middle of the month which is referred to as ‘mid-month rebalancing.’ This type of buying has been the hallmark of the bull market, and if you wanted to know where the S&P was going, all you had to do was follow the buying. On March 30 and 31, the end of the first quarter of 2015, the flow of money going into stocks reversed and there has been a steady stream of MOC selling going on ever since. Billions upon billions of stock has been sold, and one has to wonder when all this cash selling will catch up with the US stock markets.

One clear threat to the S&P right now is the continued liquidation in the oil markets. While I do not pretend to be an economist, or analyst, I do not think I have to be to understand that when energy prices drop, as they have, it is a clear indication of a global slowdown. China growth concerns are front and center in most traders’ minds. During the 6-year bull market there have been hundreds of reasons for the markets to reverse, but the current drop in energy prices and commodities could act as a precursor of things to come, as the markets head into the historically turbulent months of September and October.

Dow Death Crosses Since 1950: Welcome to the Indicator Graveyard

Are there reasons to be concerned? According to Jeffrey Hirsh from the Stock Trader’s Almanac there are:

Following up on all the hullabaloo on the recent DJIA “death cross,” we ran all the data on all the death crosses and “golden crosses” since 1950. For the uninitiated and for clarity a death cross is when a short-term moving average of an index or stock crosses below a long-term moving average and a golden cross is the reverse, when a short-term moving average crosses above a long-term moving average. It is common to use the 50-day and 200-day moving averages. And that is what happened to DJIA on August 11; its 50-day moving average crossed below its 200-day moving average. The reason it’s called a “death cross” is because it is believed to be an indicator of an imminent market decline. Back in the old days from 1950-1982 it was a decent bear market indicator, but not so much anymore. In the table I have highlighted in yellow the death cross dates before or during bear markets as well as the associated bear market bottom. Since 1982 there are a many more death crosses that occur without any major subsequent decline.

Even more significant is that most of these death crosses occurred after a substantial decline had already occurred and there was little further downside after the death cross in the short-term, generally followed by a move higher rather quickly. For the most part death crosses have occurred near low points.

On some occasions the death cross has preceded a major downdraft ahead of the bulk of a bear market move’ most of them transpired in the 1950s, 1960s, 1970s and 1980s. In recent years only the crosses in 2001, 2002 and 2008 have been indicative. We have laid out all the data for your perusal. One thing does stand out. It appears that if the market bounces a few percent higher immediately after the death cross, the next move lower appeared much more substantial.

Bottom line, there are much better indicators than the death cross in the Stock Trader’s Almanac and elsewhere. The golden cross seems much more indicative of further upside than the death cross of further downside. Since its recent death cross on August 11 DJIA was up 0.8% on the close of August 17.

DJIA is down about 5.3%, S&P is down 1.6%, since the May high, and NASDAQ is down about 3% since the July high. Being in the midst of the worst two months of the year (August and September), and with the market on shaky ground, further downside is not unlikely, but the bear does not seem to be lurking just yet. Be prepared for a further 5-10% slide before this correction ends late-summer/early-fall.

There has been so much talk about a larger stock market decline that it’s sometimes hard to see through the woods. What we do know is the S&P has been stuck in a narrow trading range for most of 2015. What we also know is that there has been massive commodity liquidation, and constant MOC selling going on in the stock market, and we all know that August, September, and October are months that tend to see stock market declines and corrections. The Federal Reserve has been talking about raising rates since March, but after Greece, China, and some of our own economic concerns, I am still not in the camp that says rates go higher in September or December, but only time will tell. After an over +200% rally in the S&P since 2009 the S&P may be stuck. I cannot rule out a pull back but I am not in the camp that says the S&P is going to crash anytime soon.

In Asia, 6 out of 11 markets closed lower (Shanghai Comp. +1.23%), and in Europe 8 out 12 of markets are trading lower (DAX -0.96%). Today’s economic calendar starts with the MBA Mortgage Applications, Consumer Price Index, EIA Petroleum Status Report, FOMC Minutes, and earnings from TGT, LOW, AEO, NTAP, SPLS, HRL, LB, CTRN, EV, SNPS, SPTN, PLKI, KEYS, CISG, MOMO, SMTC, BZUN, CO, EARS, and YOKU.

BEWARE OF THE TRIPLE THREAT

Our View: The S&P will get past the expiration, but it’s what happens after the expiration that I am worried about. Historically, September is known for many big stock market let downs / crashes, and with the Fed targeting the September meeting for a rate hike, the September Quadruple Witching, and the end of the quarter rebalance, may deliver a ‘triple threat’ to the S&P. Again, I do not think the S&P is going to crash, but I do think there is potential. I also want everyone to remember, that while October is known for some big slides, it’s also known as the ‘Bear Killer.’ Our view for today is that while Asia and Europe look weak, here in the US its the August options expiration. Its 6:00 am CT and the ESU15 is trading 2089.50. We lean to buying the weakness and expect a run for the upside stops, but with the CAC, DAX and FTSE all down over 1%, there maybe some selling around first. I don’t know if it happens today or tomorrow, but I think the stops above 2101 to 2112 could be dead ducks this week.

S&P Cash Study for the August Options Expiration

In Asia 6 out of 11 markets closed lower: Shanghai Comp. +1.23%, Hang Seng -1.31%, Nikkei -1.61%
• In Europe out 8 of 12 markets are trading lower : CAC -0.61%, DAX -1.00%, FTSE -0.93%, MICEX +0.51%, at 6:00 am CT
• Fair Value: S&P -3.44 , NASDAQ -2.14 , Dow -33.20 .
• Total Volume: 1.1mil ESU and 4k SPU traded
• Economic calendar: MBA Mortgage Applications, Consumer Price Index, EIA Petroleum Status Report, FOMC Minutes

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