One of the advantages of being a perennial bear is that eventually you get to say, “I told you so”. This incredibly strong bull market was overdue for a minor pause and I believe that is all we are seeing at this point.
The S&P 500 hit its recent all-time high on January 26th at 2873. Friday’s close at 2762 represented a decline of 3.9%. The next obvious support level would be the 50-day moving average (dma) at 2715. That would be a 5.5% decline. Many technical analysts look for minor pull backs in the 5 to 7% area and refer to corrections as declines in excess of 10%.
What triggered last week’s pull back? The most common answer cited by analysts was the FOMC announcement that suggested more interest rate increases were coming this year. That should not have been a surprise and one or two modest interest rate hikes will still leave us at historically low levels of interest.
We are in the middle of the earnings announcements for the fourth quarter of 2017 and those announcements have been generally exceeding analysts’ estimates. The effects of the recent tax law changes are only beginning to percolate through the economy. Just consider one of many examples: Apple’s announcement of investing 350 billion dollars into the U.S. economy has not yet resulted in any construction expenditures or new jobs. But it will. My point is simple. The economic foundations are strong. A minor pull back in a strong bull market is perfectly normal. There is no reason to panic.
Trading volume in the S&P companies was above the 50 dma all week as large institutions adjusted their portfolios in the face of the pull back. Many traders are locking in recent gains. When we draw the Bollinger bands on the S&P 500 chart, we see another clue as to where this pull back ends. The lower edge of the Bollinger bands® is at 2725, or down 5.2% from the high on January 26th. That 5% number is coming up frequently.
The Russell 2000 Index (RUT) closed Friday at 1547, down 64 points or 4.1% from its recent high of 1611 on January 23rd. RUT has traded much more conservatively for the past month so one might expect less of a pullback in this index. RUT broke its 50 dma at 1553 today.
The NASDAQ Composite has traded strongly in January, matching the trajectory of the S&P 500 index. Similar to SPX, trading volume in NASDAQ exceeded the 50-day moving average (dma) all week. NASDAQ closed Friday at 7241, down 3.5% from its closing high on January 26th of 7506. NASDAQ’s 50 dma stands at 7068, or down 5.8% from the 1/26 high – another number around 5%.
The volatility index of the S&P 500, VIX, closed Friday at 17.3% after opening the week at 11.7%. This remains a relatively low level of volatility. We hit 17.3% intraday on August 11th last year. I am certainly not suggesting you ignore this increase in volatility, but pull backs and corrections normally display levels of 25% or higher. Friday’s VIX, at 17.3%, was higher than any VIX number from 2017, but that was a record year for low volatility. In 2016, we hit highs of 23% in November, 26% in July, and hit 29% twice, once in January and once in February. VIX is a very good warning signal, and we should pay attention, but the current levels are far from correction territory.
My clients routinely have trailing stops and contingent stops on all stock and option positions, and Friday’s price actions certainly tripped several of those stops. But I don’t think wholesale moves to cash are warranted as yet. Monday’s price action will be a critical sign. I am inclined to think the weekend will give traders time to reflect on the market fundamentals and reduce some of the interest rate hike concern.
If we are looking at a pull back of the order of 5%, we may be close, and the 50 dma lines may be expected support levels, at least for SPX and NASDAQ. If we break the 50 dma on SPX this week, I will be making some serious moves to cash my portfolio. But I don’t expect that to be the case. The bulls just need a breather.