Investors might be feeling a little motion sick after a volatile week in the stock market. Big moves in the currency market, thanks to China, rattled traders and poured gas on the fire of worry that China is slowing down too fast. The People's Bank of China (central bank) decision to devalue their currency was the main story of the week. Meanwhile negotiations between the EU and Greece continued in the background.

The major U.S. indices managed to eke out gains for the week after a big intraday reversal higher on Wednesday. Semiconductor and biotech stocks were some of the worst performers while housing and oil stocks were up more than +3%. The U.S. dollar weakened, in spite of China's move with their yuan, and dollar weakness helped commodities bounce. Gold rebounded +2% while silver rallied +3%.

The exception to the oversold bounce in commodities was crude oil, which plunged another -3.8% for the week. WTI crude closed near $42.00 a barrel. Crude oil hasn't been this low since March 2009. It was the seventh weekly loss in a row. WTI oil is now down -56% from a year ago.

Economic Data

U.S. economic data last week was mostly benign if a little disappointing. Retail sales in June were revised higher from -0.3% to flat at 0.0%. July's retail sales number was +0.6%, slightly lower than the +0.7% estimate. Automobile sales played a big part in July's number. The seasonally adjusted annual rate for vehicle sales improved from 17.0 million in June to 17.6 million in July, which is a very strong number. Excluding auto sales the core retail sales for July was only up +0.4%, which was below estimates.

The producer price index (PPI) for July rose +0.2% following a +0.4% gain in June. Energy prices normally play a big part in the PPI but last month saw rising gasoline prices offset by declines in heating oil. Excluding food and energy the core-PPI was up +0.3%, which was stronger than expected. Year over year the PPI is still down -0.8%.

U.S. industrial production in June was revised lower from +0.2% to +0.1% while July's reading showed a +0.6% gain. The surge in July was the biggest one-month move since November 2014. Most of the rise was due to strength in the automobile and auto parts industry, which climbed +10.6%.

The University of Michigan Consumer Sentiment index slipped from 93.1 in July to 92.9 in the preliminary August survey. This was actually a hair above expectations.

Overseas Economic Data

China's devaluation of the yuan

Everywhere you looked there were headlines and opinion about China and its decision to devalue its currency. That's because the People's Bank of China (PBOC) decision to devalue the yuan against the dollar on Tuesday night was one of the largest on record. The Chinese government pegs their currency in a specific range against the dollar. For years the yuan was pegged at 8.3 per dollar. Then after 2005 they started letting the yuan appreciate, albeit very slowly and in a controlled manner. The last few months the yuan seemed to be pegged in a narrow range around 6.2 per U.S. dollar. On Tuesday the PBOC adjusted their currency and let it fall -1.9% against the dollar (the biggest one-day move since 1994).

China let the yuan slip again on Wednesday and finally held a press conference on Thursday to calm investor fears after rumor and speculation suggested they were going to let the yuan crash -10%. PBOC officials said the -10% story was nonsense and that their devaluation was about done. By the end of the week the yuan lost -3% and is currently trading near 6.39 per dollar.

A -3% drop doesn't sound like much if you're a stock or option trader but it's a huge move in the currency markets. Currencies are trading in "pips", which is 1/100th of 1%.

So why did China devalue its currency? There are plenty of opinions. On Monday China reported that its exports plunged -8.3% in July. That's the largest drop in four months. The country has been trying to transform into a more consumer-powered economy but that transformation has a long way to go and exports are still a major part of their economy. You could speculate that China weakened their currency to boost exports, since it makes their exports cheaper. Another opinion on China's devaluation suggested the country is trying to let the markets have more influence on their currency because they want to be considered a reserve currency by the IMF.

The knee-jerk reaction to the PBOC's move reignited fears of a global currency war. If China is going to devalue to make their exports more affordable overseas then everyone else might do the same thing. The yuan devaluation also fueled plenty of concern about China's economy. Maybe their economy is much worse than expected and the government is trying to drive up exports. If the Chinese economy is worse than expected then what does that say about their demand for commodities? The yuan devaluation story had a negative impact on crude oil. In spite of all the worry the Chinese Shanghai stock market index actually rallied +5.9% for the week.

Here's a chart from the Wall Street Journal on the yuan vs. dollar

WSJ's charts from the week.

If you'd like to see more history on the yuan's performance and China's decisions, visit this page. Bloomberg has a big chart going back to 2005. (Click on their chart to enlarge it).

Greece

While China was the main story for the week the Greek negotiations continued in the background. All week long there were hints and stories suggesting Greece was closing in on its third bailout deal in the last five years. Finally on Friday we heard that Eurozone finance ministers had agreed to an 86 billion euro ($96 billion) bailout while the Greek parliament also voted in favor of the deal. However, it's not done yet. Several EU nations need their governments to approve the rescue package. At the same time Greek Prime Minister Alexis Tsipras is facing huge defections from hits leftwing Syriza party. Odds are rising that Greece may have to deal with another round of elections as Tsipras suffers with crumbling political support.

Elsewhere in Europe the focus was on slowing growth. France saw its Q2 GDP fall flat (+0.0%) when economists were expecting +0.2% growth. Germany slowed down as well with Q2 GDP growth of +0.4%. That's up from Q1 but down from estimates of +0.5%. Altogether the Eurozone Q2 GDP estimate was +0.3%, which was worse than the +0.4% estimate.




Major Indices:

Last week saw the S&P 500 index plunge past its simple 200-dma but it rebounded near the 2,050 level to close up +0.6% for the week. Year to date the S&P 500 is up +1.6%. The intraday bounce on Wednesday was the biggest one-day, positive reversal since October 4, 2011, according to Dow Jones.

The action last week didn't really change anything for the S&P 500. It remains stuck in the 2,040-2,130 trading range. On a short-term basis the index has a bearish trend of lower highs so that doesn't bode well. It would not surprise me to see the S&P 500 remain in this trading range until the next FOMC meeting on September 17th, which is when most analysts expect the Fed to raise interest rates.

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

chart of the S&P 500 index:

The NASDAQ composite had a similar rebound on Wednesday. The index dipped below technical support at its 150-dma but it bounced near the 4,950 level. The NASDAQ ended Friday with a +0.09% gain for the week (less than five points). Year to date it's up +6.6%.

The 4,900 and 4,950 levels look like short-term support. Meanwhile 5,100 and the 5,165 area look like overhead resistance.

chart of the NASDAQ Composite index:

The small cap Russell 2000 index dipped toward its trend line of lower lows (see daily chart) before bouncing. It managed a +0.48% gain for the week. Fortunately the action in the $RUT last week looks like a short-term bottom. The challenge will be resistance in the 1,240-1,250 area.

chart of the Russell 2000 index



Economic Data & Event Calendar

The week ahead will bring two regional fed surveys from New York and the Philadelphia regions. We will also see the pace of inflation at the consumer level with the CPI. Analysts will be combing over the minutes from the last Fed meeting for any clues on the next one in September.

- Monday, August 17 -
New York Empire State manufacturing survey
NAHB housing market index

- Tuesday, August 18 -
Housing starts and building permits

- Wednesday, August 19 -
Consumer Price Index (CPI)
FOMC minutes from the last meeting

- Thursday, August 20 -
U.S. Existing Home sales data
Philadelphia Fed survey

- Friday, August 21 -
Eurozone consumer confidence

Additional dates to be aware of:

Sept. 7th - U.S. Markets closed for Labor Day holiday
Sept. 17th - FOMC meeting, policy update, economic forecasts
Sept. 17th - Fed Chairman Yellen press conference

Looking Ahead:

The Philadelphia Federal Reserve just released the results of their quarterly survey. They asked 42 economists for their estimates on U.S. GDP growth for Q3, Q4 and Q1 2016. Back in May the survey showed analysts estimating +3.1% growth in Q3 and +2.9% growth in Q4 while Q1 2016 was estimated to be +2.4%. The latest results have changed with new estimates showing slower growth this year and an uptick in 2016. Forecasters now expect Q3 growth to dip to +2.7% and Q4 to be +2.8%. Yet they upgraded their Q1 2016 estimate to +2.8%.

Unfortunately the forecast above seems wildly optimistic. The Atlanta Fed has done a pretty good job of nailing U.S. GDP estimates this year. Right now the Atlanta fed has downgraded their Q3 estimate from +1% down to +0.7% in just the last week. It seems a little strange that the Federal Reserve is on the verge of raising rates and yet the U.S. is likely to see growth below 1%.

The Wall Street Journal surveyed a bunch of economists and found that 82% expect the Federal Reserve to raise rates in September while only 13% expect a rate increase in December. However, it's possible that the Chinese government's currency devaluation could alter the Fed's timeline.

According to the team at FactSet, "this week's devaluation of the Chinese yuan could derail the Fed's plans for a near-term rate hike. In order to deal with slower economic growth and recent stock market turmoil, this week the People's Bank of China allowed the yuan to sharply depreciate against the U.S. dollar. The weaker yuan threatens to widen the U.S. trade deficit with China, as it makes U.S. exports more expensive and Chinese imports cheaper. It also puts upward pressure on the already-strong U.S. dollar, a trend which could force the Federal Reserve to delay its widely anticipated September rate increase."

Another factor the Fed has to consider is plunging commodity prices and the threat of deflation. As you know, crude oil is trading at lows last seen back in 2009. Odds are oil is headed even lower.

Edward Morse, head of commodities research at Citigroup, commented on the oil market saying, "A three-way game of chicken is underway. Three big buckets of global oil supply - the Organization of the Petroleum Exporting Countries, shale, and non-OPEC non-shale - are each proving to be resilient to the drop in prices, at least for now." He continued, "Saudi Arabia could raise and then sustain oil production at a massive 11 million barrels a day, while Iran sanctions relief could lead to large volume gains, and Iraqi production growth could surprise to the upside."

The Iran situation is interesting. If the nuclear deal gets approved and sanctions are lifted then Iran will be allowed to sell more oil on the global market. Maritime surveillance firm Windward estimates that Iran is storing 50 million barrels of oil in tanker ships. That's up from previous estimates of 30-40 million. They could flood the market with additional oil, which would drive prices even lower.

Citigroup is estimating a 30% chance that oil falls into the low $30s per barrel and could stay there for most of 2016. There seem to be a number of analysts suggesting oil could hit the low $30s. A few outliers are forecasting oil to fall into the $10-20 a barrel range.

Investor Sentiment

The recent volatility in the market had an interesting effect on investor sentiment. It appears to have shaken a few traders off the fence. The weekly survey by the American Association of Individual Investors (AAII) saw neutral sentiment plunge -10.6% to 33.4%. This had been stuck above 40% for a long time. Over half of the neutral investors turned bullish with bullish sentiment rising +6.1% to 30.4%. Bearish investors rose +4.5% to 36.1%. This is the 20th week in a row that bullish sentiment has been under the long-term average of 38%. According to AAII the bullish sentiment reading has been under 40% for 24 weeks in a row, which hasn't happened since 1994.

My outlook on the market hasn't changed. Big picture the markets could be stuck churning sideways until the Fed's next meeting on September 17th. This has to be one of the most anticipated FOMC meetings in years thanks to expectations for a rate hike after years of rates near zero. I suspect the biggest risk is a short-term taper tantrum. It's possible that investor sentiment sours ahead of the mid September fed meeting. If market participants are worried the economy isn't strong enough to handle a rate hike then stocks could sink.

There are a few pockets of strength in the market. I do see opportunity for LEAPS traders. Yet I want to remind readers that August and September are normally tough on stocks with a history of disappointing performances.

~ James