The U.S. stock market delivered an uneven performance last week. Investors seemed to be growing more anxious as we approached Friday, June 5th. The combination of a bid debt payment for Greece, a semiannual OPEC meeting, and the May jobs report in the U.S. was a lot to digest on Friday. Throughout the week most of the focus was on Greece as the country gets closer and closer to a potential default. Big moves in the bond market both in the U.S. and in Europe were also making headlines. The German bund market had its worst week since 1998.

Big caps were underperformers. Both the S&P 500 and the NASDAQ composite posted their second weekly loss in a row. It's worth noting the drop in the NASDAQ was very small. Buyers seemed to focus on the small caps and the Russell 2000 actually gained +1.1% for the week. Some of the groups displaying relative strength were transports (+2.5%) and banking stocks (+2.75%) while semiconductor stocks suffered widespread profit taking. The SOX index lost -2.5%.

The U.S. dollar posted a loss for the week, ending a two-week bounce, but that didn't stop weakness in commodities. Gold fell -1.7%. Silver dropped -4.2%. WTI crude oil posted a -2.3% decline for the week. Another big loser was the U.S. bond market, which plunged to new 2015 lows. The yield on the 10-year bond broke through its long-term down trend and hit levels not seen since October, ending the week at 2.4%.

Chart of the iShares U.S. Bond ETF (TLT)

Chart of the U.S. 10-year Bond Yield

Cyber security stocks were in focus after news hit of a massive data breach in the U.S. government. Hackers were able to steal information on about four million people in government databases. What's alarming is that the hackers appeared to be targeting people who had applied for security clearance. American authorities say all the clues point to China as the perpetrator behind the cyber attack. Analysts were speculating that China was looking for dirt on government employees so they could blackmail them into being spies. China responded to these allegations saying these claims are irresponsible and asks the U.S. to trust it more.

OPEC meeting

Another big story on Friday was the semiannual meeting for the Organization of the Petroleum Exporting Countries. Heading into Friday's meeting in Vienna no one was expecting the cartel to cut production and there was speculation they may even raise production. OPEC announced they would leave their official production quota of 30 million barrels per day unchanged. The funny thing is that OPEC's actual output has been above that 30 mbpd for the last 12 months in a row. They produced 31.58 mbpd in May. Both Iran and Iraq are expected to see a surge of production in the next month or two.

OPEC has essentially given up on trying to control the price of oil. Instead they want to control market share. They're willing to pump more at lower prices so it's not profitable for their rivals to compete with them. This is bad news for certain areas of the U.S. fracking industry, where the cost to produce oil might be in the $70 per barrel region. OPEC's pump at any cost approach is also terrible news for some of their struggling members who need high oil prices to pay for their government budgets. The next OPEC meeting is December 4th.

Economic Data

Most of the economic headlines last week were overshadowed by the Greek showdown in Europe. The U.S. did see an improvement in their ISM manufacturing index, which rose from 51.5 in April to 52.8 in May. Numbers above 50.0 suggest growth. Construction spending from March was revised higher from -0.6% to +0.5% while April's reading surged to +2.2%. It was the largest one-month increase since May 2012.

On Thursday Christine Lagarde, the Director for the International Monetary Fund, made headlines when she urged the U.S. to delay their next rate hike into 2016. The IMF downgraded their outlook on the U.S. economy from +3.1% growth to +2.5% growth in 2015. The IMF lowered their worldwide forecast from +3.8% to +3.1%. They're concerned that the Q1 slowdown may not be over. The IMF noted the sharp rise in the dollar and suggested the dollar might be overvalued. Raising rates would only send the dollar higher. The IMF is concerned that if the U.S. Federal Reserve raises rates too soon it will slowdown the U.S. economy which in turn will slowdown the global economy.

The very next day the nonfarm payroll report for May showed +280,000 new jobs in the U.S. That was significantly above estimates for +225,000. The March jobs number was revised up from +85,000 to +119,000. May's +280K number was the biggest monthly gain since December.

The unemployment rate rose from 5.4% to 5.5% as almost 400,000 people rejoined the workforce. The labor force participation rate inched higher from 62.8% to 62.9%, a four-month high. That leaves almost 93 million Americans not in the workforce.

One of the most notable pieces of the May jobs data was the rise in average hourly earnings, which jumped +0.3% in May. That pushed the year over year growth to +2.3%. The three-month average is up to an annual pace of +2.9%. The average hourly earnings growth has hit its strongest pace in the last five years.

According to Deutsche Bank economist Torsten Sløk, "This should put upward pressure on the entire yield curve and the dollar going forward. For equities it is positive because higher wages means higher household income, which means more demand in the economy and ultimately higher topline growth for corporate America. This is what we have been waiting for since 2009. In other words, the virtuous cycle has begun."

The Federal Reserve wants to see job growth and wage growth and May's report provided both. That's why so many suddenly believe the Fed may indeed raise rates this year. However, Jon Hilsenrath, considered by many one of the best analyst on fed moves, suggest that May's nonfarm payroll report will not trigger a June rate hike by the Federal Reserve. In Jon's blog post (here) he discusses how the Fed remains data dependent and would likely to see a string of positive reports before pulling the trigger.

Greece

It should be no surprise that Greece was one of the main stories for the market last week. Greece was supposed to make a €300 million debt payment to the IMF on Friday, which was the first of four Friday payments to the IMF this month. In a surprise move Greece announced it was not making this payment on Friday but instead asked the IMF to allow it to bundle all of its June payments into one lump sum at the end of the month. This means Greece will need to come up with €1.6 billion by month end.

It's the first time in five years that Greece has postponed a debt payment on its bailout plan from the Troika. It's also the first time since the 1980s that a country has deferred its IMF payments. The last time was the African nation of Zambia The move sparked new selling pressure across the European stock markets, which all ended lower on Friday.

Greek Prime Minister Alexis Tsipras has been negotiating with German Chancellor Merkel, French President Hollande, and the rest of the Troika (IMF, ECB, Eurozone) all week. The two sides have not been able to make any progress. Tsipras says he will not accept any further austerity or cut pensions, which is exactly what its creditors want him to do in addition to raise taxes.

The situation is tense. Greece doesn't have the money to make its IMF payments for June and it definitely does not have the money to make its larger payments to the ECB later this summer. The country needs to come to a new agreement with its creditors, which would allow it access to the next tranche of bailout funds. Without a deal Greece will default. A default opens the door to an exit from the Eurozone. Unfortunately 74% of Greeks polled do not want to leave the Eurozone. Almost half of Greek citizens are unhappy with how the left-wing Syriza party is handling negotiations. Odds are growing that Greece could face snap elections again.

Tim Edwards, the senior director of index investment strategy at Standard Poor's Dow Jones Indices, shared an interesting perspective on the situation. Tim suggests that odds are significantly higher now that Greece will default "precisely because it is now bearable." Five years ago Europe was unprepared for such an event. Today the region has had years to shore up their financial system so that a Greek default does not capsize their entire system. The GDP of Greece is less than 1.5% of the Eurozone's. If Greece were to leave it would have a negligible and temporary impact on the wider economy. You can read more on Tim's thoughts here.

Hypothetically, if Greece does default on July 1st this year. They will probably fall into some sort of grace period, which could extend this agony for another month or two. We could be looking at September before any potential Greek exit from the Eurozone.

Overseas Economic Data

There were a number of economic headlines overseas. The Bank of England left their interest rate unchanged at 0.5% and left their QE program unchanged. The European Central Bank left their interest rate policy unchanged. France said their unemployment rate ticked down from 10.4% to 10.3%. Germany's unemployment rate was better than expected and essentially unchanged at 6.4%. Germany reported their April factory orders were up +1.4% for the month and their manufacturing PMI for May was 51.1. The German Bundesbank upgraded their 2015 GDP forecast on Germany from +1.0% to +1.7% and raised their 2016 outlook from +1.6% to +1.8%. The Eurozone reported their manufacturing PMI for May was almost unchanged at 52.2 while their services PMI improved from 53.3 to 53.8. Numbers above 50.0 suggest growth. Unemployment in the Eurozone ticked down from 11.2% to 11.1%.

India's HSBC Markit manufacturing PMI data for May improved from 51.3 to 52.6. China's HSBC manufacturing PMI for May inched up from 49.1 to 49.2 while their official manufacturing PMI reading rose from 50.1 to 50.2. These tepid PMI readings fueled investors expectations for more stimulus from the Chinese government. The Chinese Shanghai index soared to new seven-year highs. The Chinese market is now trading with a P/E of 50 versus the S&P 500's P/E of 20.




Major Indices:

The S&P 500 index lost -0.69% for the week. This reduced its 2015 gains to +1.65%. The big cap index is back below its simple 50-dma and poised to either bounce or breakdown below the 100-dma. If that occurs I suspect we'll see the index fall toward technical support at the 200-dma, near price support around 2,040 (see chart).

Five-Day chart of the S&P 500 index:

chart of the S&P 500 index:

The NASDAQ composite is actually holding up reasonably well. It fell -0.03% for the week and is still up +6.6% for the year. This index is only about 40 points away from a new multi-year closing high. A close above resistance near the 5,100 level could definitely spark some short covering.

Should the market pullback continue then the NASDAQ may have support near the 5,000 and 4,900 levels.

chart of the NASDAQ Composite index:

One of the most encouraging charts among the major indices is the small cap Russell 2000 index. The $RUT rallied +1.1% for the week and has extended its 2015 gains to +4.6%. The trend of higher lows is bullish. This index still has some overhead resistance in the 1,280 area.

chart of the Russell 2000 index



Economic Data & Event Calendar

The week ahead looks pretty sparse as far as economic reports go. I suspect that the financial media will focus on the Greece situation and the next FOMC meeting, which is June 17th. Whether or not Greece defaults and when the Fed might raise rates next are the two big stories this summer (likely this year).

Believe it or not but Q2 earnings season is only one month away. Alcoa (AA) kicks it off on July 8th.

- Monday, June 8 -
(nothing significant)

- Tuesday, June 9 -
Wholesale Inventories
Japan's GDP estimate

- Wednesday, June 10 -
(nothing significant)

- Thursday, June 11 -
U.S. retail sales for May
Import/Export prices
Business Inventory data

- Friday, June 12 -
Producer Price Index (PPI)
University of Michigan Consumer Sentiment

Additional Events to be aware of:

June 17th: FOMC interest rate decision
June 17th: Fed Chairman Yellen's press conference
July 3rd: U.S. market closed for Independence Day

Looking Ahead:

The Federal Reserve is probably feeling a lot more confident about the U.S. economy following the May jobs report. They want to see a growing economy, especially after a negative Q1 GDP estimate. The good news is that after months and months of disappointing economic numbers we are seeing some improvement. Pending home sales are strong. Auto and truck sales are surging. The job market looks decent. We even have wage growth. These are all signals to the Fed that the U.S. economy is doing okay. The only missing piece seems to be consumer spending. Consumers are spending on cars and they're buying homes (thanks to low interest rates) but they are not spending much anywhere else.

Prior to Friday's jobs report the sentiment among financial pundits was starting to see some momentum for no interest rate hikes this year. After Friday's report odds of a rate hike in September are now above 50%, according to fed fund futures. Of course the Federal Reserve has promised to be data dependent so they want to see multiple months of consistent growth before raising rates. This would suggest no hike at the June meeting but a potential hike in September.

The last several weeks (maybe months) we have seen stocks sell off on any good economic news because it was seen as fuel for the Fed to raise rates. Friday's higher than expected jobs number was a big dose of data that supports raising rates. Yet stocks did not see any significant sell off. That may be a good sign. If investors can adjust their way of thinking then maybe we can get away from this good news is bad news environment. If traders can start to accept that an improving economy is better than the Fed's record-low easy money policy then raising rates will not be a bad thing.

The reason the market focuses so much on the Fed and their interest rate policy is because it affects so much in the economy and the financial system. When the Fed does raise rates the dollar should rise and bond yields should rise. In very simple terms, if the dollar rises too fast or if bond yields rise too fast there is a worry it could spark a broader market sell-off.

I am still optimistic that the path of least resistance for the U.S. market is higher. However, the biggest threat is uncertainty surrounding the Greece situation. If Greece defaults and/or leaves the Eurozone it's not going to have a huge impact on the U.S. economy. However, it could still generate a lot of waves in the financial markets. The second half of June could be critical for negotiations between Greece and its creditors in Europe. That could mean more volatility for equity markets as we approach the end of the second quarter.

~ James


"The one fact pertaining to all conditions is that they will change."
- Charles Dow, 1900