September finally posted a negative week as investors started to worry about a government shutdown. As expected headlines out of Washington D.C. overshadowed the market and traders continued to sell equities. The S&P 500 index is now down six out of the last seven trading days following the FOMC's no taper spike higher. Yet in spite of all the noise the S&P 500 is only down -1.9% from its September 18th high. Oddly enough the small cap Russell 2000 index hit new all-time highs this past week. That would suggest mutual fund managers are not truly worried about the markets yet.

Economic Data

The economic data this past week was mixed. The third estimate on U.S. Q2 GDP growth was unchanged at +2.5%. Durable goods orders inched up +0.1% after a -8.1% plunge in July. The Case-Shiller 20-city home price index rose +0.6%, which was less than expected but puts the year-over-year gain at +12.39%. New home sales for August came in at an annual pace of 412,000. Meanwhile the MBA mortgage application index rose +4.9%, its second weekly gain in a row after a huge multi-week plunge. The breakdown of the MBA index showed applications for purchases +6.6% and refi's +4.9%.

The latest reading for the consumer sentiment index fell from 81.8 in August down to 79.9 in September. Economists were expecting a the final September reading to hit 82.0. At 79.9 sentiment has fallen to the lowest level since April. Yet in spite of the falling sentiment numbers consumer spending rose +0.3% in August. You have to wonder what consumers are spending money on after a story midweek broke that suggested Wal-mart was seeing inventories pile up. On positive note AAA said gas prices fell six cents to a national average of $3.42 a gallon, which is the lowest level since January. If this trend in gas prices continues it should help boost consumer spending.

Overseas Data

Economic data overseas was also mixed. The Eurozone manufacturing PMI fell from 51.4 to 51.1. Analysts were expecting a rise to 51.8. Numbers above 50.0 indicate growth and expansion. The Eurozone Flash PMI rose to 51.5, a new two-year high. The Eurozone services PMI rallied from 50.7 to 52.1. Unfortunately consumer confidence is not improving very fast with Eurozone consumer confidence rising from -15.6 to -15.0. Meanwhile the situation in Greece is deteriorating with some claiming the Greek democracy is at stake. According to one report some Greeks are so disillusioned with the current government that they're calling for a coup. On Saturday Greek authorities arrested the leader of the neo-Nazi Golden Dawn party.

Across the Pacific Ocean there was better news with China's HSBC Flash manufacturing PMI data rising from 50.1 to 51.2. That's a six-month high and better than economists were expecting. Investors may want to note that news out of China is going to be quiet next week. Most of the nation will shut down for the week-long national "Golden Week" holiday (October 2nd through the 7th). It is estimated that over 120 million Chinese will be traveling during this holiday.

U.S. Government Shutdown

Of course the biggest story last week was the fight in Washington between democrats and republicans over the U.S. budget. The stock market knew this fight was coming, which is probably why market declines have been so mild. Thus far both parties refuse to budge and we're just hours away from what could be the next government shutdown on October 1st, 2013. There have been 18 government shutdowns since 1976 so no one thinks the world is going to end on Tuesday morning. The U.S. treasury department has talked about two separate dates as likely deadlines for when they "run out" of money. The real deadline is in the October 9th through the 17th time frame. Odds are we will see a government shutdown, which will only magnify all the political grandstanding as both sides point fingers at each other. Then sometime within the first two weeks of October the two sides will come together and get a budget bill passed.

The bad news here is that all the uncertainty about the budget could spark more selling in the stock market. The odds of a market sell-off increase if the credit-rating agencies decide to downgrade the U.S. again. The only thing we can rally count on is an increase in market volatility over the next couple of weeks.

Major Indices:

It was not a great week for the large caps. The S&P 500 continued to drift lower, down -1.0% for the week. It wasn't until a minor bounce on Thursday that the selling stalled. Yet weakness continued on Friday and as mentioned earlier the S&P 500 index is now down six out of the last seven days. Worries over the budget battle in Washington are squashing investor enthusiasm to buy stocks. The path of least resistance might be down until the politicians agree to a budget. Odds are growing significantly that we will see the S&P 500 test support near 1680. I would not be surprised to see the index dip to the next level of support near 1650 and its rising 100-dma (currently 1659).

chart of the S&P 500 index:

It is a different story for the NASDAQ composite which added +0.18% for the week and posted its fourth weekly gain in a row. Selling pressure was limited and the index continued to find support at its rising 10-dma. If I was just looking at the chart of the NASDAQ it wouldn't surprise me to see it breakout higher. However, stocks are likely to sink on news of a government shutdown. Therefore it seems more likely that the NASDAQ will retest support near the 3700 level. Stocks could always surprise us and a breakout past resistance at 3800 would indeed look bullish.

chart of the NASDAQ Composite index:

The small cap Russell 2000 index continued to show relative strength and closed at new all-time highs this past week. There is clearly short-term resistance at the 1080 level. The $RUT has bounced multiple times at its rising 10-dma. If I were just looking at the $RUT's chart I would expect a breakout higher. A close above 1080 could signal a run toward the 1100 level.

The fact that the $RUT is showing so much strength is a sign that money managers are not panicked about the budget battle in Washington, at least not yet. If fund managers were worried about a significant market decline they would sell small caps and move to more liquid large caps or just cash.

On a short-term basis the 1060 and 1040 levels look like potential support.

chart of the Russell 2000 index



Economic Data & Event Calendar

It's a new month and that means a boatload of new economic data. We'll see new manufacturing (PMI) data out of both the U.S. and China. Yet nearly all of the economic headlines will likely be overshadowed by the budget battle in Washington. The exception will probably be the nonfarm payrolls (jobs) report on Friday morning. Economists are expecting +180,000 new jobs in September.

Economic and Event Calendar

- Monday, September 30 -
U.S. Budget Deadline!
ISM Chicago (a.k.a. Chicago PMI)
China's manufacturing PMI

- Tuesday, October 01 -
Potential 1st day of U.S. Government Shutdown!
ISM Manufacturing data
construction spending
auto and truck sales
Eurozone unemployment

- Wednesday, October 02 -
ADP Employment Change report
European Central Bank (ECB) interest rate decision

- Thursday, October 03 -
Weekly Initial Jobless Claims
ISM non-manufacturing (services) data
Eurozone services PMI
Eurozone retail sales

- Friday, October 04 -
Non-farm payrolls (jobs) report (for September)
Unemployment rate

Additional Events to be aware of:

Oct. 29-30th: next (two-day) FOMC meeting

The Week Ahead:

If the budget battle in Washington wasn't bad enough we also have the U.S. debt ceiling issue again. Here's one possible scenario: The stock market could sell off as investors react to a U.S. government shutdown that begins on Tuesday, October 1st. Then the market could bounce when the two parties finally come together on a budget deal. Yet the market could sell-off again as politicians reengage the fight over the debt ceiling issue.

No one knows exactly how the budget and debt ceiling deal will play out but eventually a deal will get done. Unfortunately there is no way to tell how the markets will react to what will likely be a steady stream of negative headlines out of Washington. Although I will point out that at the moment the tone on Wall Street seems to be "buy the dip" or probably more accurately "buy the sell-off" if we see a budget or debt-ceiling inspired stock market sell-off. We have to remember that markets are fickle and attitudes can change. It seems like everyone is cautious short-term but bullish longer-term as they look toward the end of Q4 and into 2014.

I mentioned last week that September 30th was quarter end for the third quarter and that I didn't expect much window dressing. October 31st is the fiscal year end for a lot of mutual funds. Fund managers could be tempted to sell stocks after such a successful year (so far) to lock in gains and their yearend bonuses.

We also have to deal with the onset of Q3 earnings season, which starts with Alcoa (AA) reporting earnings on October 8th. Earnings season won't really pick up speed until the following week.

I hate to say it but there are always geopolitical and terror risks. The market ignored the massacre in Nairobi, Kenya where Islamic terrorist slaughtered about 70 people. The market's didn't budget when the Pakistani Taliban sent a pair of suicide bombers into a Christian church and killed 75 people and wounding over 100 more. The market is unlikely to react news out Sunday, September 29th, when Islamic terrorist murder at least 40 people at a college in Nigeria. Lord help us if there is another organized terrorist attack in the U.S.

Overall we still expect the next couple of weeks (maybe three) to be volatile. It is surprising to see so much relative strength in the NASDAQ and the Russell 2000 as both indices look ready to move higher. However, I would expect the broader market to correct lower over the next couple of weeks. Thus I would not rush into new positions now when we might see a lower entry point in mid October if we're patient.

James