It is amazing what a difference a week can make. Seven days ago the market had closed out October on a down note with a nasty breakdown under support. In the last five trading days the market has waded through a parade of mixed economic news and managed to post some decent gains for the week. Is it a bounce worth buying or is this a head fake before the next drop? More than one chart reader is suggesting the S&P 500 could be forming the right shoulder on a bearish head-and-shoulders pattern.
The biggest economic report of the week was Friday's non-farm payrolls (jobs) report. This report has already been talked about ad nauseam for the last couple of days so I'll try to be brief. Economists were expecting 175,000 in job losses in October with the headline unemployment rate ticking up from 9.8% to 9.9%. What we got was 195,000 in job losses with unemployment rising to 10.2%. Both numbers were worse than expected. August job losses were revised down for a second time from -201,000 to -154,000. September's numbers were revised lower from -263,000 to -219,000. October's read was one of the smallest amount of job losses for the year but sadly they are still job losses.
Thus far the U.S. economy has lost about 7.3 million jobs since the recession began back in December 2007. About 3.5 million have been lost since January 2009. Make no mistake about it this is a very, very tough labor market. Over 5.5 million Americans have been out of work for more than six months. The official headline number is 10.2% unemployment, which is a 26-year high. Yet the real unemployment rate, which includes those who are under employed and working part time when they really need full time work, has hit a high at 17.5% unemployment.
So why didn't the market collapse on this news? Economists have been warning us for months that unemployment would rise above 10% even as the economy began to recover. You could say we've been expecting 10% unemployment. Unfortunately we weren't really expecting it until early 2010. While job losses are getting smaller we shouldn't expect to see a big rebound in job creation. One of the worst statistics I saw this week was the average hours worked per week, which remained at a record low of 33 hours. If you're a manager you're not going to hire someone new when your current staff needs more hours. As a matter of fact you'll probably start offering overtime before you consider adding to your payroll. I've said it before. Unemployment is going to be the Achilles heel of this recovery.
Not all the data last week was bad. Retail sales figures on Thursday were better than expected. That was not too surprising since comparable figures to a year ago were terrible and easy to beat. Consumer spending remains a challenge. Jobless consumers don't spend much. Exacerbating this problem are the banks. Banks continue to reduce available credit to the consumer. It's a trend that's been happening for months. Banks just removed nearly $15 billion in consumer credit in September. That's $15 billion less that consumers have to spend with.
The big banks have another problem. They're not lending money. Instead they are hoarding cash as fast as they can. We're talking hundreds of billions of dollars. A few pundits out there believe the banks are hoarding cash because they're worried about an implosion in the commercial real estate (CRE) market. This recession start with residential real estate but banks have an even bigger exposure to CRE. There is over one trillion dollars in CRE loans that come due in the next few years. Shopping center vacancies are at a 17-year high and office-space vacancies are at a five-year high and it's going to get worse. We've heard about CRE being the "next shoe to drop" for months and months and it looks like it's starting to happen.
Now let me tell what's not happening. The inventory-rebuilding phase we keep waiting for. September was the 13th month in a row that businesses cut their inventories. That is the longest streak on record. If we combine last week's data of better than expected retail sales and add it to record low inventories one would hope that we're that much closer to the restocking phase. When it does start it should give GDP a boost for a quarter or two. Unfortunately, I concerned that it will be temporary. You may have heard analysts talking about the "new normal" where consumers are saving more and spending less. That's bad news for an economy built on consumer spending. The inventory build out may not be as robust as many hope or expect. The build-out's affect on the economy may be over estimated when it happens.
The economic calendar is pretty light this week. I would keep an eye on the dollar and interest rates. The U.S. Treasury will sell another $81 billion in bonds and the Federal Reserve will not be there to keep a floor under prices now that their $300 billion program to buy bonds has run out of money. This means that interest rates could start creeping higher as investors expect more reward for their risk of buying U.S. debt. Meanwhile the dollar will remain in the spotlight and continue to have a major influence on commodities.
Technically the market is flashing some mixed signals. If you look at the S&P 500 index the broken trendline of higher lows (support) is now acting as overhead resistance. This is normal. The S&P 500 also has resistance at its September high near 1075 and its October high near 1100. Another problem is volume. Volume on the recent sell-off was huge. Volume on the current bounce has been light. This suggests the bounce could be a head fake before the next move lower. Stocks and markets don't move in a straight line. Three steps forward and two back is normal no matter what the direction the market is moving. Bulls could argue that the market's trend of higher lows is still intact and they'd be right for the S&P 500 and the Dow Industrials. The NASDAQ, and the Russell 2000 both made lower lows. If you're looking at key sectors then the transportation sector, the semiconductor sector, and the banking sector all made lower lows. Yet oil stocks, cyclicals, retailers, and Internet stocks all made higher lows. You could say the market is fragmenting and becoming more of a stock picker's market.
I would remain VERY cautious here when it comes to launching new long-term positions. If you do I'd start with small position sizes and if the trade moves in your favor consider slowly adding to your position. If the S&P can produce a strong close over the 1100 level it would do a lot to reinforce the bullish trend and probably launch a new leg higher.
Chart of the S&P 500 Index:
Weekly Chart of the S&P 500 Index:
Chart of the Russell 2000 Index:
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 (some analysts are predicting it will not show up until 2011). Lousy consumer spending, rising foreclosures, and lagging job growth will be the main culprits. Several 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 and 2011. 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