I am going to keep my commentary pretty short tonight. Not much has changed in the last week. The earnings parade has generally been better than expected if you're willing to accept companies beating drastically lowered bottom line expectations and ignore all the top line misses. Companies can only slash costs and lay off workers so many times before it significantly impacts their business. The GDP report on Friday was better than expected but the improvement in the second quarter was somewhat overshadowed by a downwardly revised first quarter. We can probably ignore it since it's in the rearview mirror.
Right now the tone of the market is bullish. Investors are ignoring bad news and only focusing on good news. That's a great environment for the bulls but it makes me wonder what the next catalyst is going to be to spark a correction. Stocks are extremely overbought and due for a pull back. There seems to be a growing camp of traders that are pointing to the upcoming August non-farm payrolls (jobs) report this Friday, August 7th as the market event you want to get flat in front of.
The concern is that the jobs number will disappoint and finally ignite a sell-off in stocks. Yet is anyone really going to be surprised to see unemployment tick higher? They shouldn't. Everyone is expecting unemployment both here and in Europe to keep climbing well into the first half of 2010. Estimates range from 10% to 12% unemployment in the U.S. before the labor market finally reverses. So if the August jobs number "disappoints" is it really a disappointment? The bigger risk is probably an upside surprise with job losses coming in smaller than expected. Whatever the case the markets could sell the news anyway as an excuse to lock in gains. A lot of money managers and big traders go on vacation in August so volume tends to be light. Seasonally stocks don't perform well in August and September so it's another reason for money managers to sell and go on vacation. When they come back they put the kids back in school, and get ready to buy the October dip. However, 2009 hasn't followed normal seasonal trends and there is no reason for it to start now.
If we consider our current position with stocks overextended from a 10% gain off the July lows and investors nervous about the jobs report on Friday we probably shouldn't expect much from stocks Monday through Thursday. Yet I wouldn't be that concerned about a sell-off after the jobs report either. On the contrary we want to see a pull back. A lot of investors both big and small are waiting for a pull back. That's why any correction is likely to be shallow. Last week I briefly discussed why money managers are suffering from performance anxiety. They're worried about missing the move and they're worried about under performing the market. This stress is fueling their need to chase stocks higher when logically they don't want to.
Regular readers of this column know that I am concerned about how rising unemployment fuels rising foreclosures, a rising savings rate, and a decline in consumer spending. Consumer spending accounts for about 70% of our country's GDP. The second-quarter GDP report showed a 1.2% decline in consumer spending, which reversed the 0.6% gain in the first quarter. This is not going to change very fast and doesn't bode well for the back-to-school shopping season or the 2009 Christmas season. The only thing that might save the 2009 holiday season is going to be easy comparisons to last year, which was terrible. The recent housing reports that are starting to show a miniscule bounce in residential real estate is just that - a bounce. We're in the middle of summer. The last three months have been prime-time sales season. Homes are supposed to see a bounce. Sales tend to fall off a cliff in August. I've been warning readers for months that there is another wave (or two) of foreclosures on the horizon and it's not going to be pretty. Anemic consumer spending and another downturn in the housing sector are both going to be really big contributors to what will likely be the second half of a double-dip recession. The good news it that this probably won't have much of an impact until 2010.
It is starting to look like the rest of 2009 will probably be okay. Everything will depend on the steady flow of economic data and whether or not the data supports the current theory that the economy is recovering. We might still see a decline in September but that normally sets up for a fourth-quarter rally. What we should find very encouraging about the GDP report on Friday were the inventory numbers. Businesses cut inventory spending by more than $141 billion in the second quarter. That's huge! The shelves are getting bare and corporations should see an up tick in business as the country restocks their shelves. Economists are already ratcheting up their third and fourth quarter GDP forecasts based on the inventory number. Plus the cash-for-clunkers program could boost the economy. The $1 billion program was active for less than a week before it ran out of funds. At $4,500 a car that's more than 222,000 new cars sold. Congress rushed to add more funding and extend the program on Friday morning. A sharp spike in the auto industry should certainly boost the third quarter.
Weekly Chart of the S&P 500 Index:
Weekly Chart of the NASDAQ Composite:
Technically the markets are overbought. You can see above that the S&P 500 is testing resistance near the 1,000 level. The NASDAQ is also testing significant resistance at its trendline of lower highs. This overhead resistance is just one more reason that stocks could churn sideways this week ahead of the jobs report. The plan right now is to be patient and cross your fingers we get a correction. Look for support on the S&P 500 near 950.
~ James Brown