The world has become much more interconnected, especially in terms of how the markets react. China’s phenomenal growth numbers slowed a bit and inflation data for July spiked due to a surge in food prices that were short-term flood related. Retail Sales in China were up 17.9% for July, year-over-year, down from June’s reading of 18.3% and below expectations for a gain of 18.4%. Industrial Output slipped in July to 13.4% from June’s reading of 13.7%, but mainly due to a 0.8% decline in output due to shuttering heavy industry plants to meet environmental standards. The data showed slower growth, and that was all investors saw in the headline, not the actual growth statistics. Japan also saw weaker wholesale prices, off 0.1% versus expectations for a gain of 0.1%. In their volatile core machinery order number for June, the 1.6% increase was far less than the 5.5% forecast. In Europe, the reaction to the Fed’s move to reinvest payments from agency and MBS debt appeared to be insufficient and below their expectations. This disappointment was cited as the reason for heavy selling in the “risk trade” in European markets. Technology, especially Semiconductors, led the way lower. Financials were also hard hit. The FTSE ended the day down 2.4% on significant weakness in two key banking stocks, Barclays PLC (-5.8%) and Lloyds Banking (-6.8%). Tech and Financials are two key groups for any market, and to see them be hard hit from the start laid the groundwork for breaking the back of the resilient bulls.
It shouldn’t have been too surprising to have seen our Trade Balance for June fall more than anticipated, following China’s report on smaller import growth and a significant jump in exports. That had to be coming our way and did so in the recent report. The June trade gap expanded to -$49.9 billion from -$42.0 billion. Expectations were for -$42.1 billion. This is a June number, so it will have a negative impact on the recent 2nd quarter GDP revision. Just over a week ago we saw the initial report on 2nd quarter GDP indicate growth of 2.4%, pretty much in line with the 2.5% estimate. That number was actually a bit of an upside surprise at the time, and now we know it is likely to get revised lower, potentially well below 2%. Such an assessment is bound to cause economists to revisit their “double dip” scenarios. We don’t typically see the trade deficit carry so much weight, but the market has been in a narrow range that has spanned expectations for a negative quarter to having put the threat of a double dip behind us. To put that in price terms, the downside put the S & P at 1010 and the upside at 1130.
Tuesday’s market reaction to the FOMC statement may have seemed positive, in that the Fed did more than expected by laying out a plan to maintain a steady balance sheet and make purchases of long-dated Treasury paper. However, the world clearly wanted more. As we went over yesterday, the Fed can only do so much. Rates are already near zero. I would argue that the quantitative easing done to date only filled the void of capital caused by the deleveraging by the banks. In other words, what leveraged capital was removed outside of that replaced by TARP, was funded directly through the Fed. The economy was “break even”, or slightly below that target. I may still stand alone in this argument, but it is our argument from over a year ago when the Fed stepped up and said that all financial firms were too big to fail. Therefore, I don’t think the Fed will, or should, consider reducing its balance sheet from its current $2.3 trillion level. If anything, it may have to expand it some to get us out of this hole. However, to move the real economy forward, we need Congress to enact tax reform aimed at job creation. The one thing we can really count on is that Congress has no intention of cooperating on a jobs stimulus program before the elections.
At this point, we’ve transitioned from positive about earnings season, to cautious about August, to tightening stop-loss levels in anticipation of a Fall correction, to now being in the short-term bear camp. The most common question is; where do we go from here? I would venture to say that the better question would be about timing. We know that August has a history of marking short-term market highs. Ta-dah! We also know from history that October has a bad rap for being down when, in fact, it is more of a middle-of-the-road performing month. However, it often marks the low for short and long-term market declines. September is the month that should have the bad rap. There is a rational explanation for this. The end of September is not only the end of the third quarter, but it used to be the end of the fiscal year for mutual funds. With technology able to price portfolios by the second instead of at the end of the month, this may not be as much of a factor as it was in the old days, but some of those extremely large funds still use this as the end of the fiscal year. Even if they are on a calendar year, September has always been the month to do some “housecleaning”. In September 2009, the S & P was near its high for the year. Virtually anything purchased since the September prior was a winner and there was little pressure to eradicate the portfolio of any big losers. This year, September-over-September, 2009 closed at 1057. So far, this has been a fairly flat year, but a volatile one. Therefore, there may be some pressure to unload losers as we get closer to that deadline and to start Q4 fresh.
The reason for yesterday’s drop had much more to do with the fact that the economic outlook suddenly reverted back to a threat of a double dip and that the economy just wasn’t as solid as it seemed last week. The Fed did not ride to the rescue and we won’t hear from them for another month and a half. Earnings season is behind us. So where are we to find inspiration? I don’t anticipate any positive surprise from housing, jobs, the economy, or Congress. To answer the question I poised, we should be on the defensive until late-September or mid-October. As for the “where”, we should test the July low. Remember, companies are positioned for an economic dip. They are cash rich, inventory depleted, and have avoided hiring excess employees. That spells profits in a bad environment, which should translate to a more rational market decline and the potential to hold at or above the July low of 1010 on the S & P.
The world has become much more interconnected, especially in terms of how the markets react. China’s phenomenal growth numbers slowed a bit and inflation data for July spiked due to a surge in food prices that were short-term flood related. Retail Sales in China were up 17.9% for July, year-over-year, down from June’s reading of 18.3% and below expectations for a gain of 18.4%. Industrial Output slipped in July to 13.4% from June’s reading of 13.7%, but mainly due to a 0.8% decline in output due to shuttering heavy industry plants to meet environmental standards. The data showed slower growth, and that was all investors saw in the headline, not the actual growth statistics. Japan also saw weaker wholesale prices, off 0.1% versus expectations for a gain of 0.1%. In their volatile core machinery order number for June, the 1.6% increase was far less than the 5.5% forecast. In Europe, the reaction to the Fed’s move to reinvest payments from agency and MBS debt appeared to be insufficient and below their expectations. This disappointment was cited as the reason for heavy selling in the “risk trade” in European markets. Technology, especially Semiconductors, led the way lower. Financials were also hard hit. The FTSE ended the day down 2.4% on significant weakness in two key banking stocks, Barclays PLC (-5.8%) and Lloyds Banking (-6.8%). Tech and Financials are two key groups for any market, and to see them be hard hit from the start laid the groundwork for breaking the back of the resilient bulls.
It shouldn’t have been too surprising to have seen our Trade Balance for June fall more than anticipated, following China’s report on smaller import growth and a significant jump in exports. That had to be coming our way and did so in the recent report. The June trade gap expanded to -$49.9 billion from -$42.0 billion. Expectations were for -$42.1 billion. This is a June number, so it will have a negative impact on the recent 2nd quarter GDP revision. Just over a week ago we saw the initial report on 2nd quarter GDP indicate growth of 2.4%, pretty much in line with the 2.5% estimate. That number was actually a bit of an upside surprise at the time, and now we know it is likely to get revised lower, potentially well below 2%. Such an assessment is bound to cause economists to revisit their “double dip” scenarios. We don’t typically see the trade deficit carry so much weight, but the market has been in a narrow range that has spanned expectations for a negative quarter to having put the threat of a double dip behind us. To put that in price terms, the downside put the S & P at 1010 and the upside at 1130.
Tuesday’s market reaction to the FOMC statement may have seemed positive, in that the Fed did more than expected by laying out a plan to maintain a steady balance sheet and make purchases of long-dated Treasury paper. However, the world clearly wanted more. As we went over yesterday, the Fed can only do so much. Rates are already near zero. I would argue that the quantitative easing done to date only filled the void of capital caused by the deleveraging by the banks. In other words, what leveraged capital was removed outside of that replaced by TARP, was funded directly through the Fed. The economy was “break even”, or slightly below that target. I may still stand alone in this argument, but it is our argument from over a year ago when the Fed stepped up and said that all financial firms were too big to fail. Therefore, I don’t think the Fed will, or should, consider reducing its balance sheet from its current $2.3 trillion level. If anything, it may have to expand it some to get us out of this hole. However, to move the real economy forward, we need Congress to enact tax reform aimed at job creation. The one thing we can really count on is that Congress has no intention of cooperating on a jobs stimulus program before the elections.
At this point, we’ve transitioned from positive about earnings season, to cautious about August, to tightening stop-loss levels in anticipation of a Fall correction, to now being in the short-term bear camp. The most common question is; where do we go from here? I would venture to say that the better question would be about timing. We know that August has a history of marking short-term market highs. Ta-dah! We also know from history that October has a bad rap for being down when, in fact, it is more of a middle-of-the-road performing month. However, it often marks the low for short and long-term market declines. September is the month that should have the bad rap. There is a rational explanation for this. The end of September is not only the end of the third quarter, but it used to be the end of the fiscal year for mutual funds. With technology able to price portfolios by the second instead of at the end of the month, this may not be as much of a factor as it was in the old days, but some of those extremely large funds still use this as the end of the fiscal year. Even if they are on a calendar year, September has always been the month to do some “housecleaning”. In September 2009, the S & P was near its high for the year. Virtually anything purchased since the September prior was a winner and there was little pressure to eradicate the portfolio of any big losers. This year, September-over-September, 2009 closed at 1057. So far, this has been a fairly flat year, but a volatile one. Therefore, there may be some pressure to unload losers as we get closer to that deadline and to start Q4 fresh.
The reason for yesterday’s drop had much more to do with the fact that the economic outlook suddenly reverted back to a threat of a double dip and that the economy just wasn’t as solid as it seemed last week. The Fed did not ride to the rescue and we won’t hear from them for another month and a half. Earnings season is behind us. So where are we to find inspiration? I don’t anticipate any positive surprise from housing, jobs, the economy, or Congress. To answer the question I poised, we should be on the defensive until late-September or mid-October. As for the “where”, we should test the July low. Remember, companies are positioned for an economic dip. They are cash rich, inventory depleted, and have avoided hiring excess employees. That spells profits in a bad environment, which should translate to a more rational market decline and the potential to hold at or above the July low of 1010 on the S & P.