Introduction

Futures trades flat this morning pointing to a modest opening for the major indexes. The news from around the globe was largely unchanged and continues to point to a stabilizing economy. The apparently stable U.S. economy led the FOMC to stand firm on its policy at its January meeting and the ECB did the same today. Leaders in China have been holding steady on their policy as well though there is some concern for inflation. We are in a period of relative calm for the markets at this time. Earnings season is waning, political uncertainty is receding and The global economy may be gaining traction, maybe. Eyes are turning to the first quarter and what it will bring. Economic data, which is very light this week, will be the talk of the street in the coming weeks unless some political issue grabs the spotlight.


Some reasons for this time of relative calm are that the market has no expectation for changes in fiscal policy, the spending sequester/U.S. debt ceiling is expected to be resolved and signs of economic stability are rolling in every day. Just how long this can go on though is unclear. The U.S. and global economies are being propped up by the worlds central bankers and this surely can't go on forever. When fiscal stimulus ends we'll really get to see how the economy is doing.

The economy is improving but without government spending we likely would have been in recession for most of the last year or more. Our GDP data actually dipped into negative territory in the fourth quarter as I'm sure you all know. The fact the drop was mostly on a reduction in government spending helps prove my point about the U.S. economy being propped up by fiscal policy.


A new buzz word appeared in headlines today; Currency War. This new speculation is calling on the currency manipulation of the 1930's as a parallel and suggest world governments could get into a race to devalue domestic currency. I don't see any sign of this now but if the policy works for Japan then it may cause other central banks to adopt a similar policy. This is just speculation at this point but may begin appearing in more news stories.

Unemployment Claims Hold Steady

This week was a quiet one for U.S. economic data. The highlight of the calendar was today with unemployment claims. Initial claims for unemployment rose by 5,000 to 366,000. This was a surprise for analyst expecting a drop this week. This weeks data would have near flat except for an upward revision to last week's figure by 3,000 claims. The four week moving average was also revised up for last week and dropped 2,750 to 350,000 in this weeks release. The figures are still well within the range we have been seeing over the last 15-18 months. The seasonal volatility in January seems to have abated for the time being, the next calendar driven fluctuation should be in March/April around the Easter holiday. Without a prolonged decrease in this number, sub 300,000, I don't see unemployment dropping enough for the FOMC to change policy unless driven by other factors.


Continuing claims fell by around 8,000 to 3.224 million from a slight upward revision. The number of continuing claims is off the five year lows, a number reached during the holiday season, but still near the low end of the range. This figure has shown the most volatility on a week to week basis but appears to be maintaining a range between 3.15-3.25 million. Again, with no sustained drop in claims there is not much reason to expect a decrease in unemployment.


Total claims made a big drop but are still at elevated levels. The four week low of 5.590 million is a drop of more than 325,000 but is still above the pre-holiday level. The uptick in total unemployment has led a rise in total unemployment over the last two months. If this number does not trend back down unemployment data could tick up again. The highest increases in unemployment claims came from NC, OR and VA. I have bee alarmed to notice that my home state of NC has been in the top 3 on this list quite often since I have been keeping track. The layoff came from the construction and construction materials sectors. The largest declines were in California, Texas, Illinois and Florida. California said there were decreases across the board.


In another report U.S. productivity fell in the fourth quarter. Analysts had been expecting a drop of around -1.5% and got a slightly larger -2.0%. To offset this drop the previous quarter was revised up to 3.2% from 2.9%.

. Retail Sales Surprise But Don't Hold Investor Attention

Retail sales were released this morning at 9 AM. Most retailers beat expectations but the news barely caught any ones attention. Based on the comp store figures, which are only released by about 18 companies, there was little impact from the increased payroll taxes on the consumer. However, it is possible that the gains are weighted toward the front end of the month, before most people realized the actual impact on their spending power. Next month's data could be revealing. Macy's, Target and Gap all beat expectation by more than 30%. Macy's increased comp store sales by 11.7%, Target by 3.1% and Gap Stores by 8% versus expectations of 6.4%, 1.7% and 4% respectively.

The consumer discretionary ETF, XLY, followed the lead set by the general market and dropped in today's trading. Like the general market the XLY also found near term support. The ETF appears to be consolidating above that support, around the $50 level. The XLY currently looks like it could be forming a bull triangle but will need to break out to the upside to confirm. There is risk the XLY could drop below and make a correction to support. Upside target for this is $52.50 on a break above the triangle formation.

Consumer Discretionary Spyder Daily

Europe Drops On Policy Stance

The ECB maintained its interest rates at 0.75% for the month, matching expectation. The Band of England also maintained its rates as well and is continuing its own asset buying plan. Both moves were completely in line with expectation and reflective of current conditions. In the ECB statements it says they are “waiting for recovery to take hold”. In the press conference Mario Draghi basically repeated earlier statements concerning 2012 and 2013. The Eurozone was in recession for the 2nd and 3rd quarters, the 4th quarter probably saw another decline and that declines would likely continue in the 1st quarter of 2013. He also said that there should be a return to growth in the second half. My take on this is that the Eurozone is stabilizing enough to get more stimulus off the table and that there are signs of improvements. Upcoming data will be just as important in this arena as it will be here.

The recent strength in the Euro versus the dollar and the yen raised concerns it could hurt the EU recovery. Strength in the Euro could hurt exporters, an important part of GDP. Draghi made no comment on that but did say that the strength was a good sign of confidence in the Euro and the Eurozone. He also laid out some downside risk to the ECB's outlook. The Eur/USD trade tanked today after the announcements and press conference, putting some of those fears to rest. The pair fell below the important 1.3500 support level but was caught at the short term moving average. The uptrend is still intact but some more correction could be on the way. A break below the moving average could bring it down to support at 1.3250.

Eur/USD daily

Japan In Spotlight, China Awaits Data

Japan and its currency driven recovery were the basis of the currency war talk. The country is seen as the potential catalyst for other economies to use dovish policy to spur export growth. The recent adoption of a 2% inflation rate, renewed open-ended asset purchases and Prime Minister Abe's pledge of a devalued currency have already caused the yen to slide dramatically. In response the value of yen valued assets has risen. This is causing a potential bubble in Japanese stocks. The yen's move up has been very sharp and is beginning to lose steam. The USD/JPY blew past my initial target of 90 on momentum and that momentum could be turning. On the daily charts the pair is overbought and MACD is divergent while at the same time on the weekly charts momentum appears to be peaking. This doesn't mean the trade is turning but it makes me very wary of getting in at this level. For the bulls, there is multi-year resistance at 95 and for the bears support exists around 90.


China's economy is still showing signs of improvement. Earlier in the week China reported PMI numbers that point to expansion, especially in the services and construction sectors. Tomorrow China is releasing CPI figures that will be closely watched for inflation. Policy changes that helped China rebound from the 2012 downturn are working and helping to expand economic growth. There is some worry that China is not shifting its focus quickly enough and that inflation could creep into the markets there.

The Oil Index

Oil traded choppy today, first up and then down. I think there may have been hope that statements from the ECB would have been a little more bullish. I haven't seen or heard any other changes to world demand expectations. The price of crude dropped from yesterday's closing price but remained above $95. The oil index also retreated and closed the gap opened two weeks ago. Indicators are still bullish on daily and weekly charts but there is a strong possibility that the index is at the top of a long term range. A decisive break above 1350 would have a target of 1400. Support exists at 1300 and 1250.

The Oil Index daily

The Gold Index

Gold trading was very volatile following the ECB announcement press conference. The trade was steady all morning and then spiked in both directions before settling down about $7. Gold is still trapped between $1650 and $1700 and currently trading right around the mid point of that range. Economic improvement is battling with fiscal policy for control and may have come to a point. The Gold Index trade in a similar range today but finished slightly positive. The index is trading below a down trend line started in 2011 and a long term support/resistance level. The technical indicators look really weak, the index looks set to retreat to a 12 month low around $164.50.

The Gold Index daily

Earnings Update

Today list of reports was long but undistinguished. There were very few names of consequence and of those few none truly. The basic run is positive. Earnings are still more positive than good with more than 60% of S&P companies meeting or beating expectations. Guidance is still a little gloomy but nobody seems to care. The possible dip in first quarter earnings and GDP growth seems to be fully expected and accepted. It is possible the relative calm in the S&P I mentioned earlier could resolve itself by consolidating, and even correcting, at this level, in preparation for second quarter and second half of the year earnings growth. Along with stellar comp store sales growth some of the retailers offered guidance affirming first quarter and full year guidance.

The S&P 500 Index

Assuming the U.S. and world markets do continue to move forward. What lies ahead? It has taken a massive winding up of fiscal policy from global sources to get the economy to where it is today, about 60 points shy of a cyclical bull market high and the top of the secular bear market range.

SPX monthly bars

There are signs of stabilization that are leading me to think the economy could be gaining some traction. Unemployment is stable and at much better levels than just 12 months ago. The same is true of the housing market. Nothing is showing strong growth but I think there is as much chance for some positive surprise as negative, maybe more. At any rate, I think as long as the economic data supports a stable economy it will help the index to move higher. It could also lead the FOMC to turn a little hawkish and put the brakes on QE. When this happens, and I think the only question is timing, it could put an end to the cyclical bull market.

The Fed has stated that it will stimulate as long as it takes. It has already accumulated more than $3 trillion in assets, nearly equal the national yearly budget, and some speculate it could be enough or even too much. The last meeting had a slight expectation of a sign of and end to QE and if the data improves it could be right around the corner. Improving conditions will lead to more hawkish policy, weakness or as-is will keep them the as-as.

Inflation is one thing that could end QE sooner rather than later. There is already talk of inflation in China and if true could lead to hawkish moves by the Bank Of China. If the same happens here it could also lead to a more hawkish stance. Regardless, the FOMC is going to eventually have to unwind its policies and so will the ECB and China. Unwinding those policies and selling all those assets could put a real hurt bull markets around the world. The weekly charts of the SPX show a bull market long in the tooth. Momentum is bullish but divergent and stochastic is crossing into oversold territory. The index has been trending up since hitting bottom in 2008 and by my count is on the third leg of this cyclical bull. Bullish sentiment and a lack of near term head winds lead me to think the index is going to continue upward at this time.

SPX weekly

Dropping down to the daily charts I see a market in consolidation. The index is trending up and since mid November (the beginning of the third leg) the index has made two moves up with one correction occurring in late December. I would expect one more move up before this trend comes to an end.

Today's action brought the index down to near term support around 1500. The momentum has turned bearish, but with prices holding above 1500 this is good and helps to relieve some of the near term over bought condition. A break below 1500 would be bearish in the short term. The price action over the last two weeks is forming a technical pattern that could be a bullish triangle or pennant. No trading on that without a break above 1515. My upside targets remain at 1565-1570 with the possibility of the index reaching 1600 or higher.

SPX daily

Looking at charts of 30 minute bar it is easy to see near term support at 1500 and resistance at 1515. The index has been making big moves from both sides of this range since last Friday. Today was no different, the indexes daily range was the nearly the entire 15 point range for the 4th day out of 5. A break below 1500 could bring the index down as far as 1480-1470.

SPX 30 minute candles

So, to sum it all up there is a real chance that world economics and FOMC policy will continue to drive the S&P 500 higher. Long term the outlook is a little bleaker because of the waiting secular bears and an eventual unwinding of global fiscal policy. Thankfully both of these are still at least a few months away if not several quarters. Until then the index should continue to trend higher.

There is some risk of correction at this time but I think the index is making a consolidation and continuation pattern. It feels like one of those times when everyone is expecting something (a correction) so it isn't going to happen. Tomorrow could be a key day or just one more day of range bound volatility. A break above or below the near term range will probably carry over into Monday. There is also the chance that Chinese data will be a market mover. I think it wise to wait for a break out before committing any money.

Until then, keep on trading and remember the trend!

Thomas Hughes