Why is the stock market going down lately? This may seem like a rhetorical question – everybody knows about the debt ceiling wrangle after all.
However, if that was really the reason for the market's recent weakness, then one must ask: why is the treasury bond market holding up so well concurrently? After all, the US government isn't going to default on stock buybacks and dividends. If it actually defaults, it will be defaulting on the bills, notes and bonds it has issued.
We rather think that what has motivated the recent market weakness is the recognition that the US economy is weakening quite dramatically of late, in sync with the global economy (as we have previously mentioned, recently a string of unsettling PMI data has emanated from Europe and China).
The day before yesterday yet another batch of 'weaker than expected data' hit the news wires, such as a large surprise fall in durable goods orders and a very subdued collection of Fed district surveys (the so-called 'Beige Book'). Specifically the CFNAI (pdf), the Chicago Fed National Activity Index, is now very close to the level where a recession is usually expected to begin.
To top things off, the decline in home prices has accelerated, with the Case-Shiller Index once again lurching lower and hitting the fastest pace of decline since 2009.
In the same vein, a recent warning by Emerson Electric that economic activity has slowed down considerably in June and July should be taken to heart. This is the quintessential cyclical business and very finely attuned to changes in economic growth. Emerson confirmed that growth is slowing everywhere, and it specifically mentioned the US, Europe and China in its earnings call.
Below is a chart of the SPX that shows that the index is now close to what is from our point of view a 'must hold' level. If this level is broken, then our previously posted wave count of the advance from the late June low will be invalidated and an alternative wave count will have to be considered.
Moreover, it looks as though there is now a potential head and shoulders topping pattern in play. These patterns are not very reliable, but it is worth keeping it in mind – should the 'neckline' break, then the market will clearly have entered a new intermediate term downtrend. As it were, the uptrend from the 2009 lows is already in danger of being broken in many indexes (using long term monthly log charts to define the trend).
The S&P 500 and two important support levels – the short term support (the blue dotted line), a break of which would invalidate our previously suggested e-wave count of the most recent advance, and the neckline of a potential h&s formation (the red dotted line).
We would add to the foregoing that if the near term support level holds, a move to retest the highs of April remains a possible outcome. The fundamental backdrop may be quite negative, but there is still a lot of money sloshing around in the system, with US true money supply growth once again accelerating in the month of June after a brief slowdown in May.
However, no matter what the stock market does in the near term, risk remains extremely high. We have previously mentioned the high level of margin debt, which is at present closing in on the previous record high made in 2007. Doug Short has posted a series of chart updates showing the most recent data. Clearly this is not a good time to be complacent.
