The stock market rebound from its June 8th lows continued for another week. This was the best two-week run (+5.2%) in the Dow Industrials since November 2009. The DJIA managed to gain +2.3% last week. The S&P 500 rose +2.4% and the NASDAQ composite rallied +3.0%. Earnings concerns over Europe's debt worries and a mix of economic news helped fuel the move. It is worth noting that the rally's momentum seemed to stall as we approached quadruple-witching option and futures expiration on Friday.
Front page headlines were dominated by news from oil giant BP. The company's decision to fund a $20 billion victim compensation fund was a big deal. While the fund does not limit their exposure it helps quantify (a little) of what that exposure might be. However, headlines out of Europe were what moved the market. One such headline involved an international group of regulators who announced that Greece's budget cuts and austerity measures required by the EU and IMF's bailout were on track.
Another big positive was news that the country of Spain managed to sell 3.5 billion euros of debt (about $4.3 billion). Demand was strong for 3 billion in 10-year bonds with a yield of 4.86% and 479 million euros in 30-year bonds with a yield of 5.9%. Over the last few months Spain (and Portugal) have been labeled as the next country likely to face a debt default challenge. The fact that investors were willing to buy these bonds is a huge sign of confidence. Now we don't know who bought them. For all we know it was EU banks trying to put on a good show for the rest of the world but the fact remains Spain was able to sell debt. If you thought Spain was going to default in the next couple of years you wouldn't be buying their bonds.
Yet another positive headline from Europe was news that EU regulators, at a summit in Brussels, promised to reveal the results of their stress test of the major European banks. Markets hate the unknown so the fact that they are going to disclose these results is a positive. Plus, you could argue that maybe the results aren't that bad because if they were bad would the EU really reveal them. Put it all together and the euro currency saw one of its biggest one-week bounces against the dollar in over a year. Two weeks ago it hit a four-week low of $1.19 and on Friday it had risen to $1.2362 against the U.S. dollar. Now some argue that the vast majority of the euro's rise was short covering but it's a rally nonetheless. The test will be if the euro can breakout past the $1.25 level, which is expected to be resistance.
Chart of the FXE euro ETF:
Spin the globe a little further and check out some recent headlines out of China. Just announced this weekend the Chinese government has decided to increase the renminbi's "exchange-rate flexibility". Here is a quote from their announcement: "The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability." They go on to say that given this positive environment they are going to allow some flexibility in their currency's exchange rate. China has been widely criticized for manipulating their currency to keep their exports more competitive. The country has kept the yuan near 6.83 per dollar since July 2008 (FYI: China's currency is the renminbi, the yuan is merely a denomination much like our dollar). Economists consider this a huge vote of confidence for China's economy and the global recovery. This announcement could have a bullish affect on stocks this Monday.
Looking ahead at the economic calendar we're going to get existing home sales on Tuesday, New home sales on Wednesday, Durable goods orders on Thursday, the next GDP estimate on Friday and the University of Michigan consumer sentiment reading on Friday. Yet in spite of all the data the biggest event this week will be the two-day FOMC meeting. No one expects Ben Bernanke and the Federal Reserve to raise interest rates but the markets will still hold their breath on Wednesday waiting for the announcement. Recent inflation data has been bordering on the edge of deflation and with unemployment still stubbornly high the Fed has plenty of room to keeps rates near zero. There is a growing camp of opinion on Wall Street that the Fed will not only keep rates low throughout 2010 but probably through all of 2011 as well. That would be really good news. The year 2011 has a huge number of adjustable rate mortgages that will reset. I have been VERY concerned that any rise in interest rates would exacerbate the ongoing flood of foreclosures in the U.S. Maybe, just maybe, if we keep rates this low we'll see a reduction in the foreclosure problem.
I remain cautious on the stock market. The technical picture is very mixed. The cross currents I discussed a week ago are still in place. The lack of volume on this past week's rally is worrisome. Volume is a weapon of the bulls. Stocks rising on low volume can be a warning sign. It's possible we could blame it on traders just waiting for option expiration to pass. We could also blame it on normal summer low-volume trading. Whatever your opinion on the reason the fact remains low volume is a challenge.
The NASDAQ composite remains stuck under its 100-dma as it hovers near the 2300 level. The small cap Russell 2000 is still stuck near resistance around the 670 level. The S&P 500 is hovering under the 1120 level. It's a really good bet that in a week or two the 50-dma on the S&P 500 is going to cross under the 200-dma, which is normally a very bearish technical signal. You could also argue that all of the major averages look a little bit overbought given the big bounce from their June 8th lows. I would like to think we may see some end of quarter window dressing over the next eight trading days but the Stock Trader's Almanac disagrees. According to the Almanac the week after June option expiration has been down 11 years in a row.
Chart of the S&P 500 index:
The euro strength (oversold bounce or short covering rally) has pushed the U.S. dollar lower. Dollar weakness has fueled gains for both oil and gold. Gold actually hit a new all-time high on Friday near $1,260 an ounce. If investors are pouring money into gold it's not a positive sign for the stock market. Elsewhere in metals the rally in copper has stalled. If investors were truly optimistic about the global recovery then demand (and prices) for copper would be rising. That's not the case. Copper has a bearish trend of lower highs. Meanwhile the yield on the 13-week T-bill has bounced, which is a positive sign but yields on the 10-year U.S. bond have stalled. Actually 10-yr yields are consolidating sideways in a neutral pattern but odds favor a break into the prevailing trend, which is down.
Like I said, there are a lot of mixed signals and currents affecting the market. I suspect the China news regarding its currency exchange rate will be viewed as positive on Monday but it could be a one-day pop. I'm not expecting good things from the new and existing home sales numbers. You have heard it before. We could be in the eye of the storm with stocks stuck in a trading range as investors await more data (like Q2 earnings) before placing their bets on the future of the recovery.
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 late 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.
Estimates were in the 3 to 5 million foreclosures over the next three years but a White House advisor was quoted with estimates in the six to ten million range over the next three years. This only reinforces my own belief that we will see another tidal wave of foreclosed homes in 2010 and 2011. 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