Aside from the late-day rollover in the Dow Jones Industrial Average (INDU), the broader market indices spent the better part of Monday's trading basing, again. While the consolidation of the recent gains is constructive over the intermediate- and long-term, it requires discipline, nimbleness and patience on the part of traders in the short-term.
Following the better-than-expected first-quarter Gross Domestic Product (GDP) number last Friday, two economic releases this morning perpetuated the upside momentum of the market. The Chicago Purchasing Managers Index, which measures manufacturing activity in the Chicago area, rose to 38.9 during April from its 19-year low of 35 during the month of March. The Chicago number is a prelude to the National Association of Purchasing Managers Index, which is set for release Tuesday morning at 10:00 EST. The rebound of the Chicago number hints towards a recovery in the manufacturing segment of the U.S. economy, but is still well below the waterline level of 50, which means the manufacturing sector is still in recession territory.
In addition to the manufacturing data, the Commerce Department reported that personal income during March rose 0.5 percent, despite the increase in layoffs. Economists had expected personal income to rise by 0.4 percent. The better- than-expected income number supports the case that consumers will continue to spend and support the U.S. economy along its way to recovery.
Despite the relatively bullish news concerning the U.S. economy, the financial sectors of the market sharply sold-off in the latter-half of trading Monday, which did raise a small red flag. Both the Bank Sector Index (BKX.X) and the Securities Broker/Dealer Index (XBD.X) closed at or very near their session lows. Leading the move lower in the bank space were shares of Citigroup (NYSE:C), J.P. Morgan Chase (NYSE:JPM) and Bank of America (NYSE:BAC). In the broker space, shares of Merrill Lynch (NYSE:MER), Morgan Stanley Dean Witter (NYSE:MWD) and Goldman Sachs (NYSE:GS) all finished very poorly. With the Fed injecting liquidity into the system and drastically cutting interest rates, it's difficult not to be bullish on this broader group of stocks in the financial sector.
However, with the exception of Bank of America, shares of the aforementioned financials are well off their relative highs and Monday's close is somewhat a cause for concern. The explanation for Monday's slide was profit taking, as volume was relatively light in the aforementioned issues. And we're testing that idea by leaving Citigroup and American Express (NYSE:AXP) on the OptionInvestor call list this evening in an attempt to game a snapback rally in the group as early as Tuesday or Wednesday. We could be wrong with our bullish stance on the financials, so we'll want to keep a close eye on the group in the coming sessions, particularly its impact on the broader market. As I've written in the past, it's paramount for the financial sector to participate in an advance of the broader market. Otherwise, we may be faced with a bull trap.
As you can see on the chart of the BKX below, it rolled over right at the 900 level, which has been a point of resistance twice in the recent past. Below, the BKX has support at its 200-dma, which now sits at 865; thereafter, 850 marks the proverbial line in the sand. If the BKX does, in fact, breakdown below 850, my feeling is that the broader market will pullback further to retrace its recent gains. But, as long as 850 holds, the broader market should trade relatively stable.
If it weren't for the slippage in the financials Monday afternoon, we may have witnessed the Nasdaq Composite (COMPX) test its relative high near the 2200 level, which was traced following the Fed's surprise rate cut. (For those who monitor the Semiconductor Sector (SOX.X) closely, I think a COMPX at 2200 would closely coincide with a SOX at 700.)
As for the downside, or support levels, keep a close eye on the 2050 - 2075 area in the COMPX. A breakdown below that level could carry the COMPX back down to the critical 2000 level, which has already been tested twice in as many weeks. Some technicians might argue that each additional test of a support level inherently weakens it, so keep that in mind if/when the COMPX approaches 2000.
In addition to the price action I've addressed, I thought it might be prudent to peak into the market's current psychology in the form of the Market Volatility Index (VIX.X). The VIX has precipitously fallen from its relative highs around the 40 level and is approaching the lower-end of its two-year trading range, which is marked by the 20 level. To me, the sharp pullback in the VIX indicates complacency in the market, or a lack of fear.
And we can draw two conclusions from the slide in the VIX: First, there's no reason to be afraid any longer as the economy is beginning to turn and corporate profits will soon follow. Second, market participants have become too complacent and the shorts are lying patiently in the shadows, waiting to take the market back down. I don't know which of the two scenarios are going to come to fruition. But, my sense is that the market will become very news and event driven as participants await for confirmation on the economic front and catalysts in terms of corporate earnings.
Although we're winding down to the last days of first-quarter earnings season, the market will want to hear of continued improvements on the profit front starting in the second-quarter. And by improvements, I don't necessarily mean second-quarter earnings. Rather, the guidance that CEOs give the market going out six to nine months. For example, officials at data storage giant, Emc (NYSE:EMC), recently stated that they were beginning to see a slight up-tick in demand. And it's that type of improvement the market will want. We have to take the recent advance, especially in the Nasdaq, in context in that the move was predicated upon the thought that fundamentals in corporate America would begin improving in the not too distant future. And if we get a host of fresh earnings warnings and gloom speak in the coming month, the recent ramp in the broader markets is likely to reverse. After all, advance in price HAS to be supported with an advance in future earnings!
On the economic front, the market wants confirmation that the U.S. economy is rebounding and we'll be getting several crucial data points this week concerning that very subject. As I previously mentioned, the National Association of Purchasing Managers Index (NAPM) is slated for release Tuesday morning. Forecasts call for a reading of 43.9 for the month of March. In addition, the April Non-farm payrolls number is scheduled for release Friday morning, with expectations for the economy to add 27,000 jobs and for the jobless rate to rise to 4.4 percent. The jobs report is the biggest economic indicator before the Fed's May meeting and, for that reason, will be closely watched by the market Friday.
Barring any major disappointments in terms of either earnings or economic news, the broader market averages are likely to remain in consolidation mode as we've just witnessed an awful big advance. Of course, surprises to the upside on the economic and profit fronts will provide the catalyst to further advance the markets, hence my urging readers to pay close attention to news and events. Furthermore, the longer the markets stay in this consolidation mode, the stronger the rally once a catalyst is produced. Having said that, I think a prudent strategy relative to current conditions is to focus on quality names across the majority of sectors in the market from the long side. And I think that OptionInvestor has a good representation of quality on its call list in the forms of AOL Time Warner (NYSE:AOL), American Eagle Outfitters (NASDAQ:AEOS), Eli Lilly (NYSE:LLY), Alcoa (NYSE:AA) and Citigroup, although the latter traded poorly Monday. I'm by no means recommending to go out and recklessly buy these names, as I have no way of quantifying each of my readers' risk tolerance and/or time horizons. Rather, my point is turn my readers' focus to the types of stocks in the market that are trading well and are likely to continue to work higher in light of the potential for a rebound in the economy and benign monetary environment. And with the exception of the minor red flags in the financial pullback Monday and the VIX, the bias appears to be slightly titled to the upside, from where I sit.