China reassured the world markets and economies that they were not looking to unload Euro sovereign debt. I’m sure they are always “looking” at their portfolio holdings, but the markets had overreacted to the statement. On Wednesday, we had a nice follow-through day to Tuesday’s attempted reversal. The Dow was up about 120 points. After the reaction to the Financial Times story on China, the Dow finished the day down 70 points, a swing of about 190. To start the day, the averages pretty much took back everything they lost in the second half of Wednesday’s trading. Even the Euro started Wednesday at 1.2345 and ended yesterday at 1.2353. However, the round-trip intraday took the Euro to a new 4-year low and that caused the panic out of stocks, especially the riskier assets. Tuesday’s low undercut the February low in the Dow and S & P on an intraday basis. The NASDAQ and Russell 2000 were so strong off of the February low that these two indices were still above support. Had the market closed up healthily on Wednesday, we would have been singing the praises of a solid follow-through and a good low in the market. Unfortunately, the news threw a wrench into the works. However, the proof came yesterday. We didn’t just take back what we lost on Wednesday. We did that and added another confirming day. We don’t really have to go back down and test Tuesday’s low, as that low was a “test” of the 1000 point crash day and the February low. We feel confident that the low is in for the summer rally. Sure, we may back and fill this next week, building a base for a “summer rally”, but the catalyst won’t be the Euro or China. The focus will be on earnings.
Getting a bounce off of an extreme low is easy. What makes it the start of something more is all about “what” bounces and how strong. First, let’s look at what trailed in the advance. Household and Personal Products, Pharmaceuticals, Food Retailers, Utilities, Food/Beverage/Tobacco, Healthcare Equipment & Services, and Telecommunications were up, but were the bottom of the performance list. The reason is that these are THE most defensive groups for equity investors. This is where you hide, not where you invest for growth and earnings. Looking at the flip side of this trade, Real Estate, Autos, Semis, Insurance, Banks, Energy, Diversified Financial, Materials, Media, and Hardware/Equipment Tech were the best performers. These groups were the ones that were so badly beaten in the mass exodus of the risk trade and the unwinding of the Euro. The Euro is only at 1.23, a far cry from where it broke down at 1.32. However, the groups adversely impacted by that action were discounting 1.16, 1.10, or even parity. What appears to have been a good turn for the equity market also appears to be a reasonable short-term turn in the Euro, bolstering these groups. However, I would say that investors were more aggressive about taking on that risk and buying back several of these hard hit stocks.
Richmond Fed President Lacker told reporters that he was less comfortable with the phrase “extended period” in the Fed statement on interest rates. Lacker is not a voting member. The good news was that he is more bullish on steady economic growth, looking for 3% this year. The hard-line stance on rates may not go too far. 1st quarter GDP was revised lower, mainly due to small downward revision across a broad range of component data. Personal Consumptions was adjusted down 0.13% to 2.42%. Consumption is 70% of GDP. Inventories were revised slightly higher to an increase of $33.9 billion from $31.1 billion. However, one needs to remember that this is the first uptick following 6 consecutive quarters of decline that had erased $480 billion from inventory. Expectations were for GDP to be revised to up 3.4% from up 3.2%. The downward revision to 3.0% is enough below expectations that one shouldn’t be looking at this data as supporting a more aggressive stance on the Fed funds rate.
Inflation remains rather benign. First quarter core PCE was up just 0.6%, unchanged from its initial forecast. Weekly jobless claims slipped to 460,000, slightly higher than the 455,000 estimate. The prior week was revised up 3, to 474, 000. It’s not a disturbingly high number, but moving back above 450,000 for two straight weeks is another sign that companies are likely to remain conservative with their spending capital for new hires. Throw in the worries from the likely slowdown in Europe and one would have no reason to get overly excited about the economic recovery at this stage. We need to make a very clear distinction between the economic forecasts, employment forecasts, and that for corporate earnings and the stock market. The economy is bouncing back to a pace of very modest growth, probably sub 2% considering the increase in inventories, on an annualized basis, added 1.65% to GDP in Q1. That only leaves growth of 1.35%. With growth at this level, and probably set to struggle for the 2nd and 3rd quarters, we shouldn’t expect many openings for new jobs. However, the market reflects profitability. Companies couldn’t be better positioned for slow growth. The S & P companies are sitting on over $1 trillion in cash and cash equivalents. Capacity Utilization is at 73.7%, well below a norm of over 80%. Companies have been reluctant to hire, so costs have been kept low. Finally, inventory levels are still down significantly. This means they are lean, mean, money-making machines. Even if revenues are up less than 2%, those companies deriving profits from domestic operations should be doing quite well in this 2nd quarter. Therefore, earnings should be the driving force for the market going forward.
Technically, I think the turn off of Tuesday’s low was solid. We may spend a week building a base, but weakness should be bought over the next two weeks in anticipation of a summer rally. The S & P closed at 1103 and its 200-day moving average is at 1104.50. We could see some resistance here. However, the summer rally should target 1150 to 1170. It is possible to get as high as 1200, but we’d be a seller in July at that level. This would be a 5% to 7% increase from here, so we’d get more aggressive on any pullback. Technology, Consumer sensitive, and Retail would be a good short-term play. Financials bounced nicely, but will be more volatile targeting the July 4th deadline to vote on the financial reform package.
China reassured the world markets and economies that they were not looking to unload Euro sovereign debt. I’m sure they are always “looking” at their portfolio holdings, but the markets had overreacted to the statement. On Wednesday, we had a nice follow-through day to Tuesday’s attempted reversal. The Dow was up about 120 points. After the reaction to the Financial Times story on China, the Dow finished the day down 70 points, a swing of about 190. To start the day, the averages pretty much took back everything they lost in the second half of Wednesday’s trading. Even the Euro started Wednesday at 1.2345 and ended yesterday at 1.2353. However, the round-trip intraday took the Euro to a new 4-year low and that caused the panic out of stocks, especially the riskier assets. Tuesday’s low undercut the February low in the Dow and S & P on an intraday basis. The NASDAQ and Russell 2000 were so strong off of the February low that these two indices were still above support. Had the market closed up healthily on Wednesday, we would have been singing the praises of a solid follow-through and a good low in the market. Unfortunately, the news threw a wrench into the works. However, the proof came yesterday. We didn’t just take back what we lost on Wednesday. We did that and added another confirming day. We don’t really have to go back down and test Tuesday’s low, as that low was a “test” of the 1000 point crash day and the February low. We feel confident that the low is in for the summer rally. Sure, we may back and fill this next week, building a base for a “summer rally”, but the catalyst won’t be the Euro or China. The focus will be on earnings.
Getting a bounce off of an extreme low is easy. What makes it the start of something more is all about “what” bounces and how strong. First, let’s look at what trailed in the advance. Household and Personal Products, Pharmaceuticals, Food Retailers, Utilities, Food/Beverage/Tobacco, Healthcare Equipment & Services, and Telecommunications were up, but were the bottom of the performance list. The reason is that these are THE most defensive groups for equity investors. This is where you hide, not where you invest for growth and earnings. Looking at the flip side of this trade, Real Estate, Autos, Semis, Insurance, Banks, Energy, Diversified Financial, Materials, Media, and Hardware/Equipment Tech were the best performers. These groups were the ones that were so badly beaten in the mass exodus of the risk trade and the unwinding of the Euro. The Euro is only at 1.23, a far cry from where it broke down at 1.32. However, the groups adversely impacted by that action were discounting 1.16, 1.10, or even parity. What appears to have been a good turn for the equity market also appears to be a reasonable short-term turn in the Euro, bolstering these groups. However, I would say that investors were more aggressive about taking on that risk and buying back several of these hard hit stocks.
Richmond Fed President Lacker told reporters that he was less comfortable with the phrase “extended period” in the Fed statement on interest rates. Lacker is not a voting member. The good news was that he is more bullish on steady economic growth, looking for 3% this year. The hard-line stance on rates may not go too far. 1st quarter GDP was revised lower, mainly due to small downward revision across a broad range of component data. Personal Consumptions was adjusted down 0.13% to 2.42%. Consumption is 70% of GDP. Inventories were revised slightly higher to an increase of $33.9 billion from $31.1 billion. However, one needs to remember that this is the first uptick following 6 consecutive quarters of decline that had erased $480 billion from inventory. Expectations were for GDP to be revised to up 3.4% from up 3.2%. The downward revision to 3.0% is enough below expectations that one shouldn’t be looking at this data as supporting a more aggressive stance on the Fed funds rate.
Inflation remains rather benign. First quarter core PCE was up just 0.6%, unchanged from its initial forecast. Weekly jobless claims slipped to 460,000, slightly higher than the 455,000 estimate. The prior week was revised up 3, to 474, 000. It’s not a disturbingly high number, but moving back above 450,000 for two straight weeks is another sign that companies are likely to remain conservative with their spending capital for new hires. Throw in the worries from the likely slowdown in Europe and one would have no reason to get overly excited about the economic recovery at this stage. We need to make a very clear distinction between the economic forecasts, employment forecasts, and that for corporate earnings and the stock market. The economy is bouncing back to a pace of very modest growth, probably sub 2% considering the increase in inventories, on an annualized basis, added 1.65% to GDP in Q1. That only leaves growth of 1.35%. With growth at this level, and probably set to struggle for the 2nd and 3rd quarters, we shouldn’t expect many openings for new jobs. However, the market reflects profitability. Companies couldn’t be better positioned for slow growth. The S & P companies are sitting on over $1 trillion in cash and cash equivalents. Capacity Utilization is at 73.7%, well below a norm of over 80%. Companies have been reluctant to hire, so costs have been kept low. Finally, inventory levels are still down significantly. This means they are lean, mean, money-making machines. Even if revenues are up less than 2%, those companies deriving profits from domestic operations should be doing quite well in this 2nd quarter. Therefore, earnings should be the driving force for the market going forward.
Technically, I think the turn off of Tuesday’s low was solid. We may spend a week building a base, but weakness should be bought over the next two weeks in anticipation of a summer rally. The S & P closed at 1103 and its 200-day moving average is at 1104.50. We could see some resistance here. However, the summer rally should target 1150 to 1170. It is possible to get as high as 1200, but we’d be a seller in July at that level. This would be a 5% to 7% increase from here, so we’d get more aggressive on any pullback. Technology, Consumer sensitive, and Retail would be a good short-term play. Financials bounced nicely, but will be more volatile targeting the July 4th deadline to vote on the financial reform package.