The month of July turned out to be the stock market's best month in a year. The major averages delivered +7% gains but readers should keep that in perspective. The second half of June saw an -8% decline and by the July 1st intraday low the April-July correction had sank to -17%. The market was oversold and better than expected earnings news was enough to fuel some short covering. Thus far of the 336 S&P 500 companies that have reported their Q2 earnings about 75% have beat Wall Street's earnings estimates. The number that have beat the revenue estimates slips to 64% but still a healthy figure. On average Q2 profits are up 45%, which is a lot higher than the 30% analysts were estimating a few weeks ago. Unfortunately, now that we're past the midpoint of earnings season the impact from earnings news will diminish.
Economic data continues to come in mixed. Most of the reports are confirming the U.S. economy is slowing down. This past week the markets digested news from the New York ISM, Chicago ISM, Consumer Sentiment, and the preliminary look at U.S. Q2 GDP. The economic slowdown is making investors nervous and money continues to flow into the safety of bonds and fixed income securities. Demand for the Treasury Department's recent bond auctions has been very strong. Meanwhile yields on the two-year note hit an all-time low of 0.549% on Friday. The yield on the ten-year bond sank to 2.91%.
Overall July was a good month for stocks around the globe with big gains in Asia and Europe. The Japanese market lagged its peers. The NIKKEI average lost -1.6% on Friday in spite of a wave of positive earnings reports from high-profile companies like Sony Corp., Panasonic Corp., Honda Motor Co., Hitachi Ltd., Sharp Corp., and Nissan Motor Co. For the month of July the NIKKEI gained +1.6% following a -4% decline in June.
The results were a lot stronger in China. The Hong Kong Hang Seng snapped an eight-day winning streak on Friday with a -0.3% decline but ended the month of July with a +4.48% gain, its best month since September 2009. The Chinese Shanghai index outperformed with a +10% gain in July but to keep that in perspective the Shanghai is still down almost -20% for the year. Economic data out of China this weekend could be a market mover on Monday. The Chinese government will announce their PMI data for July. Last month the China PMI sank from 53.9 in May to 52.1 in June. Economists are expecting July to slip to 51.1. Any number above 50 represents growth and expansion. If Sunday's report disappoints, we should expect some serious profit taking after a +10% rally in the Chinese market.
The major European market ended the month with gains that mirrored the U.S. The big event in July was the results from the European bank stress tests. While many believe these tests were flawed, investors seem to have accepted the news and run with it. It certainly seems like fears over Europe's debt crisis are fading if the euro's strength is any indication. I do want to point out that the rebound in the euro is now eight weeks old and could be nearing resistance in the $1.31-1.32 zone.
Chart of the FXE euro ETF:
Here at home the Q2 earnings season continues but we are moving into the last few innings of the game. We will hear from hundreds of companies this week but the major headlines will actually be dominated by economic reports. Let's look at the recent economic reports first. On Friday the Chicago ISM Purchasing Managers Index rose from 59.1 in June to 62.3 in July. This was above economists' estimates for a drop to 56.5. Unfortunately, this bounce appears to be a temporary effect given General Motors' decision to postpone the retooling process this year and keep their plants open, when normally there is a seasonal shutdown. Thus production for the Chicago area was artificially higher than normal. Not affected by GM's decision was the New York ISM, which saw a minor move from 458.9 in June to 463.1 in July. Yet the current conditions component fell from 69.3 to 58.4. The expectations component slipped from 69.6 to 67.5. These are the lowest levels in almost a year for both key components.
Of course the big report this past week was Friday's preliminary look at U.S. Q2 GDP growth. The market was expecting growth of +2.5% but evidently Wall Street's whisper number was closer to +4% growth. Naturally investors were disappointed when the Commerce Department said Q2 growth came in at +2.4%. There were a number of revisions with the Commerce Department adjusting the Q1 numbers from +2.7% growth to +3.7%. For all of 2009 U.S. GDP sank -2.6%, which was the worst drop since 1946.
Fueling the growth in Q2 was a +17% jump in business investment, up from +7.8% in the first quarter, this was the biggest gain since Q1 2006. Businesses ramped up spending on software and equipment, which saw their biggest growth in 13 years. Unfortunately the focus is on productivity so corporations can squeeze out more from their current staff instead of hiring. The GDP report showed that businesses continued to restock their shelves with inventory growth rising from $44.1 billion in Q1 to $75.7 billion in Q2. Part of this build up was due to a big increase in imports (consumers bought more imports than U.S. goods). This is actually fueling fears that American corporations could end the year with too much inventory. Another concern is that the big build up in inventories will mean business demand and manufacturing to restock shelves will slow down in the second half of 2010, thus further exacerbating any slowdown.
There is always a focus on the consumer and the GDP report showed that consumer spending is falling. The Commerce Department revised Q1 consumer spending from +3% to +1.9%. Their Q2 estimate put consumer spending at an anemic +1.6%. A recent survey showed that 80% of Americans are cutting back. They are putting off big purchases. They are downgrading to generic brands. They are eating out less and cooking more. Plus, Americans are saving more, a lot more. Friday's GDP report showed that the savings rate rose to 6.2%, the highest level in a year. This is long-term bullish as consumers repair their personal balance sheets and pay down debts but it will make the country's economic rebound that much slower since so much of our economy is fueled by consumer spending.
Overall the GDP report was disappointing. The government's record-breaking $862 billion stimulus package is winding down. Government spending will fade. Local and state governments are already facing huge budget shortfalls and will continue to cut back. Momentum is clearly slowing and the consumer is cutting back. This will keep businesses on the defensive and unlikely to hire. There are concerns the unemployment rate will bounce back above 10%. Economists believe that the U.S. needs to average +3% growth in GDP just to keep pace with our population increase. It is estimated that the U.S. would need to see an average of +5% GDP growth for an entire year just bring down the unemployment level by 1%. Now you see why the Fed believes it will take several years for the U.S. to reach "normal" unemployment levels again.
Speaking of the Fed, the Federal Reserve realizes the economy is still in jeopardy. Chairman Ben Bernanke shared the Fed's view that the economic outlook was "unusually uncertain". St. Louis Federal Reserve governor James Bullard made headlines this past week with interviews and a paper on his concerns that the U.S. could be facing a deflationary environment similar to Japan. Bullard is worried that the Fed's "extended period" stance on interest rates is dangerous and he favors more quantitative easing where the Fed resumes buying long-term U.S. treasuries to help spur the economy. While he isn't advocating immediate action he wants the Fed to be prepared should conditions worsen. Bullard feels that "The U.S. is closer to a Japan-style outcome today than at any time in recent history."
Another Fed head making headlines was Dallas Federal Reserve governor Richard Fisher, who had some very interesting comments on how this past year's regulatory changes on healthcare and finance reform is retarding our economic rebound. Fisher believes that,
"Businesses and consumers are being confronted with so many potential changes in the taxes and regulations that govern their behavior that they are uncertain about how to proceed downfield. Until business operators are provided the clarity they need, they will continue to hoard their cash, limit their payrolls and constrain investment in new plant and equipment-none of which provides hope for the unemployed or will put us on a more forceful path to recovery."
He suspects that American businesses will stay cautious until after the 2010 elections.
Technically the market picture is still muddy. Short-term the pattern is bullish but at the same time the rally stalled at resistance for many of the major averages and most still have a bearish trend of lower highs. The S&P 500 failed near 1,120 and its simple 200-dma. On a short-term chart, traders have been buying the dips every time the S&P 500 sees a 50% retracement of the rally (from the July lows going forward). Longer term I still think there is a good chance the S&P 500 corrects down toward the 950 area but that could take several months and we could see a strong rally into the end of 2010 before this occurs. Currency moves will continue to have an influence on trading so we need to keep an eye on the euro and the U.S. dollar. I've produced a chart of the FXE euro ETF above. You'll see a chart of the UUP dollar ETF below.
Hourly chart of the S&P 500 index:
Weekly chart of the S&P 500 index:
Weekly chart of the UUP dollar ETF:
The tech-heavy NASDAQ has a similar pattern of lower highs. Traders did buy the dip on Friday near the 50-dma. Short-term I would expect this index to bounce. Whether or not it can close over 2300 and its 100-dma is a good question.
Daily chart of the NASDAQ index:
This past week saw the 50-dma cross under the 200-dma on the small cap Russell 2000 index. This is normally a very bearish technical indicator but the rebound in July was pretty encouraging. The $RUT index failed at resistance near 670 but traders bought the dip twice near 640 and its major moving averages (50 & 200). The weekly chart looks like a potential top but I suspect the $RUT is ready to bounce higher again. Of course stocks might churn sideways until the jobs report on Friday.
Daily chart of the Russell 2000 index:
Two sectors I would keep an eye on are the banks and the transports. The financials are a major section of the market and without a rally in the financials the market will not be able to sustain a move higher. The BIX banking index has been struggling with resistance near the 140-141 zone but it also seems to be coiling for a bullish breakout higher. A close over 142, or especially the 145 mark, would be a bullish signal. Meanwhile the transports have seen a big run up off their July lows and stalled right at resistance. Traditionally Dow Theory suggests we can't have a prolonged bull market without participation in the transports. Earnings comments and guidance from heavy hitters like UPS and FDX were bullish as both companies raised their guidance. Short-term the transports look a little overbought but a close over the 4500 level would be a bullish development.
Daily chart of the BIX banking index:
Daily chart of the Dow Jones Transportation index:
I also want to point out that the Baltic Dry Goods index is improving. After a multi-week plummet the $BDI is seeing a two-week, oversold bounce. Has sentiment changed? Or is this just a technical correction? The $BDI measures prices for shipping rates on tankers. Lower demand for shipping means lower prices and vice versa. The plunge in rates suggest there is less demand for shipping and thus an indication that global business activity has slowed down dramatically. This uptick in the $BDI is a positive sign but it has a long way to go before I'd call it bullish.
Daily chart of the Baltic Dry Goods index:
Looking ahead economic headlines will likely overshadow any earnings news. There are lots of reports this week but the major ones will be the ISM numbers and the Jobs report. While not a complete list here are the reports to watch for: On Sunday night, the Chinese PMI release. On Monday, the ISM manufacturing report. On Tuesday, Factory Orders and Pending Home Sales. On Wednesday, ADP (private) employment report and the ISM services number. On Thursday, the weekly initial jobless claims and Chain Store (same-store) sales for July. Friday is the non-farm (jobs) payroll report. Right now estimates are for the two ISM reports to show a slowing pace of growth but growth nonetheless. On Friday economists are expecting the unemployment rate to tick up from 9.5% to 9.6% and they expect private businesses to add +90,000 jobs. The actual headline jobs number will be -75,000 jobs due to temporary census jobs ending.
In summary the market's short-term trend is still up but I'm doubtful it will last. There is a strong chance that stocks will merely chop sideways until Friday's jobs report. I would actually rather see the market correct lower, retest its early July lows and then rally. A bounce from the July lows could be a bullish entry point to ride a rally into Christmas. It is important to note that the risk of a double-dip recession is still front and center but the positive spin from the Q2's earnings season has been pretty strong. Corporate guidance was a lot healthier than expected. Maybe the market can grind its way higher. However, readers need to bear in mind that the 2010 election cycle will be a heated one with several tight races. There will be lots of negative publicity about how bad the economy is and how the candidate speaking can make it all better. All of the negative ads and newsbytes could have a bearish effect on an already weak consumer sentiment. This could end up keeping the markets in neutral (or worse) until after the elections are over.
I would hesitate to place any big bets in the next several weeks but we need to be flexible and adjust as market conditions change. I am still concerned about a double-dip recession. Cautious businesses are unlikely to hire, which will keep unemployment high, and this will encumber any economic recovery.
~ James Brown