Bulls are scared and on the run as the market ends October on a down note. What makes last week so frightening is the S&P 500's breakdown under support near the 1050 level, its 50-dma, and its long-term trendline off its March 2009 lows. It was also the end of the fiscal year for many fund managers who may not feel the need to chase performance any longer. After a 60% rally off the March lows the S&P 500 is probably due for a larger decline.
Earnings season is still in progress but investors' attention has turned to economic data. The economic data we have been getting has been mixed. The market rallied on Thursday thanks to a better than expected GDP number. Yet the move looked like it was all short covering. Many analysts are starting to think that with all the government stimulus the third quarter GDP results were mostly a one-time gain. A number of economists are expecting fourth quarter GDP to fall into the +1.5% to +2.5% zone. Not everyone agrees. A few more bullish analysts are raising their GDP numbers to north of +4%. The main reason behind rising estimates are the falling inventory numbers. Inventory levels in the U.S. have continued to slide and that means we should be nearing a significant inventory rebuilding phase for the economy. Unfortunately we've been expecting this rebuilding phase for a couple of quarters now.
The stock market action over the last couple of weeks has been fueling new speculation that the climb off the 2009 lows is nothing more than a massive bear-market rally. We're also hearing more and more analysts considering the double-dip recession scenario. I've been warning investors about a double-dip recession for months. The economic picture gets pretty muddy when we look toward the second and third quarters of 2010.
On a short-term basis the market appears to have formed a top. Small caps and transports have been leading it lower. Both of these sectors now seem a little oversold and due for a bounce. We're also seeing corrections in energy, miners, and technology. On Friday the semiconductor index broke support near 300 and its 100-dma. The financials were really hammered pretty hard last week and the banking indices have dropped to three-month lows. Investors are worried that some of the major banks will still have to raise significant capital by selling more stock, which would dilute shareholders.
I would expect next week to be flat to down. We might see an oversold bounce but I wouldn't expect it to last. We have a lot of economic data about to hit the wires. The nationwide ISM manufacturing report comes out on Monday. The ISM services data comes out on Wednesday. The FOMC will announce their decision on interest rates around 2:15 p.m. on Wednesday. No one expects Ben Bernanke to raise rates but their comments about the state of the economy and how soon they might raise rates could easily move the markets. On Friday the big report everyone will be waiting for is the non-farm payrolls (jobs) report. Job losses have been declining but they're still job losses. We've been hearing about how any recovery would be a jobless recovery for months now. We've been warned that unemployment would continue to climb even as the economy improved. Now that the GDP has turned positive the focus will sharpen even more on employment. Right now estimates are for 175,000 lost jobs for the month of October.
We also need to keep an eye on the U.S. dollar. The dollar has been in decline since its peak last March. Two weeks ago the dollar was nearing its lows from 2008. Last week looks like a short squeeze. The short dollar trade is extremely crowded. If the dollar can reverse higher it will put bearish pressure on commodities. It will also have a negative impact on our exports. The long-term trend for the dollar appears to be down but it is still very oversold and probably due for a more significant correction higher.
Study the S&P 500 for a moment. Now that we've broken support the next level of support appears to be the 1,000 level and its 100-dma. If the 1,000 level doesn't hold I would expect a decline toward the 950 level. A 10% correction from the S&P 500's high at 1100 would be 990 and a 15% correction is about 935. I would become extremely worried if the S&P 500 closed under the 950 level.
Chart of the S&P 500 Index:
Weekly Chart of the S&P 500 Index:
Chart of the Russell 2000 Index:
Chart of the Dollar ETF (UUP):
LONGER TERM OUTLOOK
Previous Comments on my Long-Term Outlook:
My long-term outlook has not changed. I still expect the economy to see a double-dip, "W"-shaped rebound with the second dip in 2010. Lousy consumer spending, rising foreclosures, and lagging job growth will be the main culprits. A few weeks ago there were some comments out of the U.S. Treasury concerning foreclosures. The Obama administration's HAMP loan modification program can only help a certain number of homeowners and one official said that even if the HAMP program was a total success we should still expect millions of new foreclosures. This only reinforces my own belief that we will see another tidal wave of foreclosed homes in 2010. Some analysts are forecasting upwards of six million foreclosures in the next three years. What is that going to do to consumer confidence and consumer spending? It's not going to help! You can review my long-term outlook here. It's the second half our my "Two Months Left" commentary.
~ James Brown