WEEKLY UPDATE

July 26, 2010



With last week's rally the stock market has now been trading sideways for the past 8 weeks and is now testing a key level of resistance, the 200-day moving average (200MA). Analysts are hopeful that the market can definitively break above the 200MA, possibly signaling that the market can hold these general levels. The market did break above the 200MA briefly in June but could not hold those levels and subsequently fell to new lows. The market has spent a lot of energy just climbing to the 200MA and is not likely to break solidly above this level without substantially stronger economic news.





Bonds weaken slightly on Friday following the release of the European stress tests

U.S. government bonds have been a safe-haven investment for over a year now, but they recently have been in even greater demand as many have grown concerned over a looming sovereign debt crisis in Europe. On Friday the long-awaited European bank stress test results were released and it gave a sigh of relief to investors who feared the worst. This allowed for a slight pullback in bond prices, but this does not signal a change in their direction. Below is a chart of how various bond ETFs have traded over the past three months.





Conclusion

Stocks have rallied to reach a key level of resistance. If stocks can rally through the 200MA it will likely gather more short-term momentum, but if it fails to break above the 200MA level, selling in stocks will likely resume. Bonds have done well and have taken a day off after reaching crisis-level prices. We will know in the next day or two which way stocks are headed in the short term; however, the long-term direction is still toward weaker prices.

Take care,
Greg

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July 16, 2010

Weakness Shows up in Economic Activity

Factories Slow Down

Reports from the New York and Philadelphia Federal Reserve Banks showed that regional manufacturing growth is slowing, causing concerns that the one area of economic growth (manufacturing) is headed for a double dip.

Deflation replaces Inflation

U.S. producer prices fell for the third-straight month in June, signaling that deflation is the trend as economic activity weakens.

Consumer Sentiment Weakens

The economic realities of tight credit and low employment are being reflected in consumer sentiment data - on Friday, the Reuters/University of Michigan survey of consumer sentiment for July was released - it fell from 76 (June) to 66.5 (July). This move erased all gains made in the past 11 months and caused the DJIA to plummet over 200 points.

Bond Prices Remain Steady as the Economy Softens

U.S. treasury and government-guaranteed bonds continue to be safe havens to investors who are concerned about the uncertainty swirling around the U.S. economy. The list of concerns can go on and on but one can see them summed up in the prices of bonds today. Below is a chart of the iShares MBS (Mortgage-Backed Securities) ETF. This chart shows the trend toward higher bond prices all month long.



A Tug of War has kept the Stock Market Volatile

So far corporate earnings have been just good enough to fight the headwinds of weak economic activity. The chart below shows the S&P 500 stock index and how it is trading within a downward channel (shown by the two red trend-lines). Two weeks ago I mentioned that the stock market was oversold and due for a bounce. That bounce occurred last week and now the market is overbought and ready to move lower. The market could move higher but to gain more momentum it will need to either close above its 200-day moving average or receive decidedly stronger economic or corporate news next week.



Next week should be interesting. We will be hearing from more companies about their earnings, we will hear about new building permits on Monday followed by housing starts on Tuesday, and the Conference Board will release the latest Leading Economic Indicators data on Thursday. With all this data due out we will see if the bond rally can continue and if stocks will turn lower.

Take care,
Greg

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July 12, 2010

Stock Investors React to (Short-term) Oversold Conditions

Following weeks of selling the stock market rallied last week to relieve a deeply oversold condition; this is known as a counter-trend rally. The rally is likely to end this week but could be extended a bit further if corporate earnings come in stronger than expected. Alcoa is the first to release their earnings on Monday, followed with tech giant Intel on Tuesday. Analysts will listen carefully to the guidance from these companies before deciding if their appetite for stocks remains or another leg lower is in store for the market. For now the trend is still in place for lower prices.

We have mentioned before that the market's trend is now lower but it is moving in classic stair-stepping fashion or, in other words, the market is taking two steps down and one up. This is illustrated in the chart below:



What this chart shows is there have been two steps down and two "half-steps" up since the market correction began back on April 19th. The initial low is shown as (B) on the chart, followed by a rally that retraced 50% of the loss (C), The next move lower ended as (D) on the chart and Friday's close gave the market a 62% retracement of that decline marked as item (E). Counter-trend rallies such as these usually peak within a band of 50 to 60% of the previous decline. Today's action in the market reached a classic Elliott Wave peak so a technical analyst would normally expect the market to move lower; nevertheless, the market may have a little more steam if corporate earnings are stronger than expected.

Want to know where our stock market is headed? Follow China's Lead.

The most interesting chart I saw last week was the one below. This chart shows how the U.S. Market is no longer the leader among markets around the world. Our market, like most others, is now following the lead set by China. This chart shows how the Chinese stock market peaked months before ours did in 2007; bottomed out before ours in 2008 and peaked again late last year - months before our market peaked earlier this year.



Why is the Chinese market leading ours up and down?

The Chinese stock market is leading ours because U.S. consumers no longer have the cash or credit to keep buying discretionary items so companies are now depending on the buying power of China to lead consumer spending. The Chinese stock market is much more attuned to their economic health than ours is so it makes sense to see that our stock market follows their lead.

Take care,
Greg

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July 6, 2010

Friday's Employment Figures show a Loss for June

Analysts were looking for anywhere from 50,000 jobs gained in June to a loss of over 100,000 - when the final tally was complete, we found that 125,000 net jobs were lost in June. Meanwhile the unemployment rate fell from 9.7% to 9.5%. Sadly this is because 652,000 unemployed workers became discouraged and stopped looking for work, thus exiting the labor force and the unemployment rate calculation. Had these people not become discouraged, the unemployment rate would have moved up to 10.1% in June. 6.8 million Americans are still long-term unemployed, having been out of work for more than 26 weeks.

Because Congress failed to extend unemployment benefits, the unemployment rate should continue to fall as more people will be lost in the labor force calculation.

The U.S. Service Sector Disappoints for June

Our service sector, which represents 80% of our GDP, grew slower than expected in June with the ISM's non-manufacturing activity index falling from 55.4 (May) to 53.8 (June) when 54.9 was expected. Even more surprising, employment in the service sector actually contracted, with the ISM's nonmanufacturing employment index falling from 50.4 (May) to 49.7 (June), where any reading below 50 shows a contraction. The director of the survey, Anthony Nieves, said the report indicated a "slow, jobless recovery."

Global Demand for Commodities Falls

The Baltic Dry index, which quantifies global demand for commodities, fell for the 28th consecutive day on Tuesday. This is the worst losing streak in 6 years and bodes very badly for global economic growth.

Stocks Enjoy a Short-lived Bounce off of Over-sold Conditions

Despite the wave of bad economic data on Tuesday, the DJIA rallied up 171 points from word by the Reserve Bank of Australia that it maintains confidence in the growth of China, and Asia more broadly. The stock market however has been trading downward recently and is struggling to hold gains for more than a day or two. The DJIA only finished up 57 points on Tuesday after the 171 intra-day high.

This chart shows the recent action in the S&P 500 and the pattern that has developed during this correction.



Corporate Earnings may Stabilize the Stock Market for the Short Term

With markets so volatile, investors are hoping for good news from corporate CEOs next week when they begin to report earnings from the second quarter. If the earnings are not great, investors can at least hope that CEOs will give optimistic guidance for future profits. Such news may allow the stock market to stabilize at these levels, but it will still face adversity coming from the headwinds of low economic activity, unemployed and reluctant consumers, higher taxes, and an uncertain regulatory future.

Bonds Continue to Rally

No news here. U.S. Treasuries continue to be stable with an inclination for higher prices and lower yields. This is good news for us; but the bad news is that Treasuries are getting over-bought and will eventually have to pull back a bit. The question is, When will this occur? We continue to watch for signs of a short-term correction in government bond prices and we expect to adjust appropriately as the change develops.

Take care,
Greg