Fears that the Federal Reserve might taper their QE program in December fueled broad-based selling and postponed any Santa Claus rally on Wall Street. There seems to be a growing camp of analysts suggesting that the Fed might taper at the December meeting this week and that has market participants on edge. Stocks could also be suffering from tax loss selling and fund rebalancing before year end.
By Friday's closing bell the S&P 500 was down -1.65% for the week. The NASDAQ composite lost -1.5% and the small cap Russell 2000 index lost -2.1%. The transportation average lost -1.5%. The semiconductor index slipped -1.9%. A drop in crude oil helped fuel a -2.4% pullback in oil stocks. Biotechs really underperformed with a -2.8% decline for the week. Yet in spite of this weakness the Russell 2000 is holding at round-number support near the 1100 mark. The NASDAQ is holding near the 4,000 mark. The S&P 500 index is hovering above short-term support near 1,775. The volatility index may have bounced but there still is not much fear in this market.
U.S. economic data continues to come in mixed. We should be used to that by now. Overall retail sales numbers for November came in better than expected with a +0.7% gain. That follows an upwardly revised October reading of +0.6%, up from +0.4%. That's encouraging since consumer spending is believed to account for almost 70% of the U.S. economy.
The ISM services (non-manufacturing) index data for November was not quite so promising. This index fell to a new five-month low at 53.9. Numbers above 50.0 indicate growth. The Producer Price Index is a look at inflation at the wholesale level. November's PPI reading dropped -0.1%, marking its third monthly decline in a row. This is quietly fueling fears of deflation and provides another reason for the Fed to be in no hurry to taper their QE program.
Economic data out of Europe seems to be slowing down. Industrial production for the EU plunged -1.1% compared to estimates for +0.3% growth. Helping fuel that decline was a -1.2% month-over-month drop in Germany's industrial production. Investor sentiment toward Europe has been positive in recent months because of the perception that the debt crisis has cooled. That confidence might be misplaced. Both Italy and Spain saw their debt levels hit new record highs. Italy has a GDP of $2.06 trillion. Their government debt just hit $2.85 trillion. According to a new Reuters article Spain's debt hit 93.4% of its GDP. The Spanish government expects its debt-to-GDP ratio to hit 101% between the years 2015 and 2016. Everyone knows that U.S. interest rates will rise, likely starting in 2014. Rising interest rates in the U.S. will also put pressure on interest rates in European markets. If they rise too high or too fast it will jeopardize the already struggling EU members with too much debt.
Meanwhile in Asia the Japanese economy's Q3 GDP growth was revised down from +1.9% to +1.1% year over year growth. It's a significant drop from their Q2 growth of +3.6%. Japan did say their industrial production rose +1.0% month-over-month, which was better than expected. The Japanese yen fell to a new five-year low against the dollar, which should be bullish for Japanese exporters. Speaking of exports, China said their exports rose +12.7% in November, which was significantly better than the +7% estimate. China also reported that their November retail sales came in at a better than expected +13.7% and their industrial production rose +10%.
Last week's pullback in the S&P 500 has pared its year to date gains to +24.5%. The index did breakdown below prior support near 1780 but it is holding near the prior highs from late October and early November (see chart). I suspect that if the S&P 500 can hold the 1770 level it will bounce. Otherwise a breakdown below 1770 probably means we'll see a drop toward 1750.
If the S&P 500 index does bounce then look for potential resistance at 1800 and 1810.
chart of the S&P 500 index:
Weekly chart of the S&P 500 index:
The NASDAQ composite's -1.5% decline has trimmed its year to date gains down to a still impressive +32.5%. Most of last week's losses were from Wednesday's drop. The fact that the NASDAQ has been able to hold on to round-number support at the 4,000 mark is encouraging. However, I will point out that on the weekly chart, last week's pullback has created a bearish engulfing candlestick reversal pattern. It's a pattern that does need to see confirmation so no need to panic yet.
If the NASDAQ continues to fall we can watch for potential support at 3950, the 50-dma near 3935, and the 3900 level.
chart of the NASDAQ Composite index:
Weekly chart of the NASDAQ Composite index:
The small cap Russell 2000 index was one of the worst performers among the major indices with a -2.1% decline last week. Fortunately the $RUT has managed to hold at round-number support near the 1100 mark, a level that is underpinned by a trend line of higher lows (see chart).
The long-term trend is still up. However, the $RUT could drop toward the next level of support near 1080 and still maintain its up trend. If the $RUT can bounce from here then we're back to watching for potential resistance at 1120 and 1140 again. Year to date the $RUT is up +30.3%.
chart of the Russell 2000 index
Weekly chart of the Russell 2000 index
Economic Data & Event Calendar
Last week we had some great news with the democrat and republican negotiators coming together on a two-year U.S. budget deal. In the true spirit of compromise both sides were relatively unhappy with the details of the deal. Congress approved the new budget deal with a 332-94 vote. The budget now moves to the Senate, which should vote on it Tuesday. While there are plenty of opponents the budget is expected to pass. Should the Senate fail to approve it the news would be negative for the stock market.
There are plenty of economic reports coming out this week but there is only one event that matters. That event is the two-day FOMC meeting that concludes on Wednesday afternoon. It is Federal Reserve Chairman Ben Bernanke's last meeting. No one expects the fed to alter interest rates and the focus will be on their statement and if they decide to taper their $85 billion-a-month QE program. Bernanke will have a press conference on Wednesday after the FOMC meeting.
A Reuters poll of sixty economists found that one month ago only three were expecting the Fed to taper in December versus 37 that expected the Fed to taper in March 2014. The most recent poll now shows that 12 expect the Fed to taper in December and 32 expect March. The rest were expecting the Fed to taper in January.
Some have suggested that the Fed might only reduce their QE program by $5 billion. That wouldn't be very significant except that it would signal that the taper has begun and the Fed will slowly be removing the punchbowl from the QE party. It probably doesn't matter how much they taper but if they taper that will move the market.
Those against a December taper will point out that the Fed has consistently claimed any decision would be data dependent. The Fed said they wanted to see the unemployment rate at 6.5% and job growth at +200,000 a month or more. Currently the unemployment rate is at 7% and over the last three months we are averaging +193K new jobs a month. That's close to their stated goals but is that close enough?
Something else to consider is the new two-year budget deal did not address the U.S. debt ceiling. This issue returns in February 2014 and it will be hotly debated in Washington. The Fed may want to wait until after the debt ceiling issue has been resolved before tapering any QE program.
Economic and Event Calendar
- Monday, December 16 -
New York Empire State manufacturing survey
U.S. industrial production data
Eurozone manufacturing PMI data
- Tuesday, December 17 -
Consumer Price Index (CPI) on retail level inflation
FOMC meeting (two-day meeting begins)
U.S. Senate expected to vote (and pass) two-year budget deal
- Wednesday, December 18 -
housing starts and building permits
FOMC rate decision (two-day meeting ends)
Post-Fed meeting Ben Bernanke press conference
- Thursday, December 19 -
Weekly Initial Jobless Claims
Philadelphia Fed survey
existing home sales data
- Friday, December 20 -
U.S. Q3 GDP estimate (previously +3.6%)
Eurozone consumer confidence
Additional Events to be aware of:
Dec. 24th - U.S. stock market closes early
Dec. 25th - U.S. stock market closed for Christmas
Jan. 1st - U.S. markets closed for New Year's Day
Feb. 7th - U.S. debt ceiling is reached
All of the potential warning signals discussed in late week's commentary remain. As a matter of fact the bullish-bearish investor sentiment numbers have gotten worse. The Investor's Intelligence sentiment poll has seen the number of bulls rise from an extreme 57.1 to a new high at 58.2. We haven't seen this much bullish sentiment since October 2007. If you recall that was the top of the market right before the financial crisis and -50% drop in the market. The number of bearish investors remained unchanged at 14.3%, a low not seen since 1987. These extremes do not mean the market is going to reverse immediately but they are a warning signal.
Another troubling observation last week was data from Reuters, who has been tracking earnings guidance and earnings warnings. Thus far the number of earnings warnings in Q4 are the worst on record. Historically for every one company that raises their earnings guidance there are 2.2 companies that issue negative guidance. Currently the numbers for this quarter have soared to 11.4 companies issuing negative guidance for every positive guidance.
Reuters chart: negative guidance
Looking at the week ahead we should be in the midst of a Santa Claus rally on Wall Street. Unfortunately, Santa is likely to avoid the corner of Broad and Wall until after the FOMC decision on Wednesday. If the Fed does decide to taper their QE program then they could scare Santa away completely. It really does boil down to the FOMC meeting. I would not be surprised to see stocks drift sideways until Wednesday afternoon. Then the markets will move based on if there is a taper or not. No taper likely sparks a rally that lasts until yearend. If there is a taper then stocks will most likely see a knee-jerk reaction sell off lower.