Investors are growing more fearful over the fate of the economic rebound. The economy has clearly slowed down but is it a temporary "soft patch" or the beginning of the second dip? Throughout the week the markets digested CPI data, consumer sentiment numbers, U.S. trade figures, July retail sales, a Fed meeting, and CSCO's earnings report. As you can see the market has an upset stomach. Stocks posted their fourth loss in a row on Friday as traders ignored better than expected GDP data out of Europe. Money continued to seek safe haven securities while commodities stalled as the dollar rallied.
There was a number of economic reports out of Europe this past week. Greece said their GDP shrank for the seventh quarter in a row but that wasn't a surprise. Spain said their GDP rose +0.2% quarter over quarter but it was down -0.2% year over year. France reported Q2 GDP growth of +0.6%, which was better than the +0.5% estimate. Economists were expecting Germany's GDP to grow +1.3% but the country reported a shocking +2.2% surge in the second quarter. This was the best quarterly growth rate since 1991, when they started keeping records for a reunified Germany. Of course all of these numbers are subject to revision. The sad fact is investors were not impressed by the news and markets remained jittery.
Speaking of revisions, there is a big worry that the U.S. is going to significantly revise our Q2 GDP estimates. On Wednesday the Commerce Department issued their June trade figures. Investors were expecting a jump in the trade deficit but no one was expecting it to jump $49.9 billion. That was a +18.8% jump from May to June with American exports falling -1.3% to $150.5 billion while imports surged +3% to $200.3 billion. The Commerce Department is going to have to revise their Q2 GDP estimates from an already disappointing +2.4% growth down toward +1.5-1.0% growth. The Commerce Department will release its revised Q2 GDP estimates on Friday, August 27th. This report helped spark the widespread sell-off on Wednesday where stocks broke below support.
Weakness in the stock market and concerns over a double dip have exacerbated the flight to safety. The U.S. dollar has seen a massive rally against the euro (but hit 15-year lows against the Japanese yen). The yield on the 10-year U.S. bond is under 2.7% while the yield on the 2-year U.S. treasury hit another all-time record low under 0.5% this past week. Germany's bonds, another safe-haven security, have seen the yield on the 10-year bund fall under 2.45%. Investors are so desperate for safety the rush of money into TIPS has pushed the yield on the five-year TIPS to almost zero (0.0%).
Daily chart of the U.S. dollar ETF (UUP):
Weekly chart of the Yield on the 10-year U.S. bond:
Quickly touching on economic news for last week the Labor Department said the Consumer Price Index rose +0.3%, which broke a three-month decline, but it was all due to a rise in energy prices. The core CPI only rose +0.1%. If you average the core CPI over the last year it comes out to +1.2%, which is the slowest pace of inflation since the year 1966. Retail sales for July were slightly ahead of expectations with +0.4% improvement over the +0.3% estimate. Unfortunately, this was again due to energy prices with gasoline on the rise and a little help from auto sales. If you exclude gasoline and autos then July retail sales actually fell -0.1%.
Meanwhile the early August reading on consumer sentiment saw improvement. After a big drop last month the University of Michigan consumer sentiment figures rose +1.8 points to 69.6 although I suspect this data was collected prior to Wednesday's big drop in the stock market. The next reading may see this minor bounce evaporate. Lastly there was a fed meeting on Tuesday the 10th. There was no change in rates as expected. Unfortunately the market was looking for some sort of quantitative easing from the Fed to help spur the economy. They did announce a small form of easing by rolling over the expiring mortgage debt they own into U.S. bonds but the market wasn't very impressed.
Another downer last week was earnings from technology bellwether Cisco Systems (CSCO). The company managed to beat profit estimates by a penny but missed on the revenue side. It was still a very strong quarter and a strong year for CSCO but management reiterated the "uncertainty" worries that has been plaguing corporate guidance and circling around the U.S. and European central banks. Combine CSCO's disappointing comments and revenue miss with some downgrades for the PC industry and it was a very tough week for technology stocks.
Technically the stock market looks weak and vulnerable. I have been warning readers to expect this breakdown as stocks struggled near resistance from inside a bear-wedge consolidation pattern. The path of least resistance is down. The S&P 500 is holding near short-term support near 1080. If stocks manage a bounce from here I would expect it to fail and roll over in the 1100-1120 zone. As stocks continue lower we can look for levels of support in the 1050-1040 zone and the July lows near 1020-1010. Longer-term if the S&P 500 breaks down under the 1,000 level we are probably looking at a drop toward 950-940.
Daily chart of the S&P 500 index:
Weekly chart of the S&P 500 index:
If the market weakness continues we could see the small cap Russell 2000 index break under its July lows, which would forecast a drop toward support near 550. Another sector I would watch is the SOX semiconductor index. The SOX broke down sharply this past week and closed under significant support near the 330-325 area. This is very bearish and doesn't bode well for tech stocks and the NASDAQ. We also want to keep an eye on the transports and the financials. The market can't rally for long without either sector participating.
Daily chart of the Russell 2000 index:
Daily chart of the SOX semiconductor index:
Earnings season is effectively over but we will still hear from a handful of retail companies this week. Some of the big names reporting are Home Depot (HD), Lowes (LOW), Target (TGT), and Abercrombie and Fitch (ANF). Stocks will remain sensitive to economic data. A few reports to watch out for are the Producer Price Index (PPI) due out on Tuesday (estimates are for +0.2%). The Philly Fed report comes out on Thursday. The weekly initial jobless claims will also come out on Thursday. The last couple of weeks have been very disappointing with new claims jumping significantly above estimates. Last week there were 484,000 new claims. This week the market is expecting 475,000 initial jobless claims. Rising jobless claims only add to fears of a double dip recession. Goldman Sachs actually raised their estimates that we will see a double dip to 30% on Friday. There are plenty of analysts that put the risk at 50%.
Looking ahead not much has changed from last week aside from the breakdown in stocks. I still don't see a reason for investors to buy stocks. We are in the middle of the worst two months of the year for stocks. Investors are crossing their fingers that the back-to-school shopping season will be stronger than expected but that's just wishful thinking at this point. The debt crisis in Europe hasn't been solved. The surge in Germany's GDP numbers are encouraging the rest of the euro zone is struggling. Traders are still worried about a deft default with southern Europe CDS spreads getting wider.
I am worried that we're going to see an ugly midterm election cycle. Investors may be on the sidelines until after the November elections are over. The hail of rhetoric is only going to get worse over the next several weeks. I'm also very concerned about the consumer. The job market is not improving. That will keep consumer nervous who will continue to save more, which will impede our economic rebound. Of course it's all a vicious circle that feeds on itself.
Optimistically the market will find support near its July lows, base there for a little while and then mount a year-end rally. I've got my fingers crossed.
~ James Brown