Stock markets fell heavily in August, rebounded sharply, then consolidated the lows in September. Having retested lower levels and found support, traders then took prices higher in the US and around the globe into the start of earnings season. But, so far, with so many firms undershooting their revenue targets, the rally has stalled.
There are obviously many potential reasons for this, but Chris Weston, IG’s Australian-based chief market strategist, released a note to clients today highlighting a number of market-based factors that constrain the S&P rally and with it, a global rally.
Weston said his “overriding view is that the S&P 500 is looking vulnerable and there are a number of the longer-term charts that suggest the market could be going much lower.”
He’s not calling a crash but added “the index is absolutely testing key resistance levels and a rejection and sell-off from here would be very telling indeed”.
Indeed, Weston highlights that, at the moment, the S&P 500 could be characterised as a market in “consolidation after the multi-year trend break”, while the number of S&P 500 companies above their 50-day moving average (a trader tool to gauge direction) is rising.
That could continue Weston says.
Likewise, he highlights that short-term traders have been betting the S&P 500 will fall for most of 2015.
“The fast money traders have been negative on the market since January, swinging from a net long position of 150,000 contracts to recently stand at a net short position of -278,000 contracts. Last week this short position was reduced 12% to currently stand at -244k contracts, which naturally benefited the cash market,” he wrote.
That’s important because Weston says the risk of further short covering (speculative buying because the price moves against them) is “high”. Overall, he says the positioning of the speculative traders matters because they are betting prices will fall.
But, more than balancing out the short term positioning of the speculative community Weston believes is the moves in US margin debt (people borrowing to buy stocks), which he says is rolling over.
“This is a potential bearish development and something worth keeping an eye on, as previous corrections have started with a margin debt being sharply reduced,” he said.
He doesn’t mention Chinese margin debt and the role it played in the recent big fall in Chinese stocks, but as happened during that sell off, margin calls by lenders fuelled the selling. Of course the causality normally runs from the fall in prices, leading to margin calls, leading to selling, leading to more margin calls.
US margin debt at such heights poses a real downward risk to prices on the S&P 500, even if stock owners simply trim their positions, sell and pay back debt.
Following the argument Weston makes, and the chart on the relationship between margin debt and stock market prices since 2007, it’s easy to see much lower levels for the S&P 500. They are the blue lines and arrows on Weston’s chart.
That could be really bad news for local traders.