Dedicated market observers already know that not much has changed in the last week. Stocks have been consolidating sideways but the S&P 500 index doesn't have enough fuel to power past resistance near 1150. It's widely expected that last minute quarter-end window dressing kept the market near its highs for the month. It was quite a month with the markets delivering their best September performance since 1939. Yet now we face the third-quarter earnings season, a mid-term election, and fiscal year end for many mutual funds on October 31st. At the same time the flow of economic data continues to be mixed and does not show a strong U.S. economy. Meanwhile the Chinese economy continue to chug along with positive readings on the latest PMI reports. Expectations that the Federal Reserve will embark on a new round of quantitative easing is pushing the dollar lower on a daily basis, which is fueling a huge rally in gold. The price of gold has soared to new all-time highs over $1,300.00 an ounce.
I'm going to quickly touch on some of the recent economic data. Personal income improved with a +0.5% gain, which was better than expected. Spending also rose, coming in at +0.4%. Unfortunately the rise in personal income appears to have come from extended and emergency unemployment in August so it's not real and will eventually fade away. On a more positive note the spending is real and seems to be steady. Construction spending jumped to +0.4% in August, which was significantly better than the -0.4% economists were expecting. Sadly most of the construction spending came from government projects and not private funding.
The final reading for September consumer sentiment showed up positive. Analysts were expecting it to come in relatively flat to the mid-month reading of 66.6 but consumer sentiment improved to 68.2. It is assumed that a positive trend in consumer confidence will translate into stronger consumer spending. To keep things in perspective consumer confidence is lagging behind normal levels, which averaged 84.5 over the past decade and averaged 97 during the last U.S. expansion.
The ISM manufacturing report (a.k.a. Purchaser manager's index, PMI report) that came out on Friday was a disappointment. The ISM slipped from 56.3 in August to 54.4 in September. Numbers above 50.0 indicate growth and expansion but it's starting to move the wrong direction (lower). New orders slipped from 53.1 to 51.1 and backorders fell from 51.5 to 46.5, which does not indicate a strong growth environment as we head into the fourth quarter. The inventory gauge rose from 51.4 to 55.6, which would suggest demand is slowing down. If demand is waning then there is no need to ramp up production or higher more workers.
Next week's major economic reports will be the ISM services index and the September jobs report (non-farm payroll data). The ISM services number comes out on Tuesday. This is relevant because the U.S. economy is largely service oriented. Economists are expecting a small improvement from 51.5 to 51.8. The bigger report next week is the jobs number. The headline number is expected to rise from 67,000 new jobs to 70,000 new jobs. Of course the number to watch for is the private employment. Last month private sector job growth came in at +67K. Unfortunately next Friday's report will still be tainted by the last remaining census worker layoffs. Given the condition of state budgets right now I won't be surprise to see another unexpected rise in state government layoffs.
We only have thirty days left until the midterm elections. You can expect the rhetoric to really heat up. As the mud slinging intensifies it could have a negative impact on consumer and investor sentiment. On a much more positive note there is a very strong historical pattern of market gains in the next 12 months following a midterm election (no matter who wins the vote). The stock market hates uncertainty and just getting past the elections will remove a level of uncertainty about what to expect from Washington next year. Money managers are well aware of this trend and we expect investors to start placing their bets for a fourth-quarter rally ahead of the election. Thus the second half of October, or at least the last week, should have a positive trend.
Speaking of trends, the market's short-term trend is up. Yet the upward momentum has stalled. The S&P 500 can't seem to get past resistance near 1150. Throw a Fibonacci retracement tool on the S&P 500 and stretch it from support near 1040 (August lows) to the recent highs near 1150. You'll see the 38.2% Fib retracement hits 1108. That's where I would expect a market pull back in a "normal" market. Yet this time I suspect any correction will be shallower than normal. As I said earlier there are too many people waiting for a pull back to jump on board. I'm not saying it can't fall that low. I would love to see a dip to 1100 on the S&P 500 so we can buy it. Realistically I'm watching the 1120 level and expect it to hold up as decent support, underpinned by the simple 200-dma.
Daily chart of the S&P 500 index:
As you know most of the major averages look similar. They're all very extended from their August lows and look ripe for a pull back. The question is, where will traders buy the dip? I'm looking for the NASDAQ composite to find support near 2300. The small cap Russell 2000 should see some support in the 660-640 range. I know that's kind of a wide range but the small caps tend to be more volatile. The Dow Transports should see some support in the 4350 area. I'm still watching the SOX semiconductor index too. Normally the chips tend to lead the NASDAQ. While the SOX has been showing strength it still has a bearish pattern of lower highs.
Daily chart of the NASDAQ index:
Daily chart of the Russell 2000 index:
Daily chart of the Dow Jones Transportation index:
Daily chart of the SOX semiconductor index:
Some of the biggest events this month, outside of the jobs report and pre-election headlines, will be the third-quarter earnings season and the fiscal year end for mutual funds. Everyone expects the third quarter to have been very weak. With that in mind we could see stocks rally because their earnings results "could have been worse!" On the other hand, after a +10% rally in September, any significant miss is going to be a big signal to sell and lock in gains. The question is how will mutual funds react? Their yearend is coming up quick. They're going to want to get rid of their losers but they also want to lock in some gains and do a little window dressing as well. Given my outlook for a fourth-quarter rally, investors will probably use any post-earnings weakness as a potential entry point on the stronger companies.
In summary, we want to buy the dip. If I had to guess I'm looking for a correction in the Oct. 6th to the 20th time frame but that's just a guess. The jobs report and Q3 earnings announcements could spark a lot of volatility. Watch the support levels listed above and wait for the correction. Or if you're feeling cautious then wait for the bounce to start before initiating positions.
Editor's Note: The LEAPStrader newsletter next week (Oct.9th) will not come out until Monday (Oct. 11th).