The summer roller coaster ride in the stock market continues. The combination of a new quarter with the normal inflow of funds to money managers and a small turnaround in sentiment for the banks helped power the best weekly gain for the year. Investors are feeling more confident that the European stress tests will show the 91 banks participating are in better shape than expected. Now add to the mix some decent economic news like Germany's strong May export data and a drop in the weekly initial jobless claims here in the U.S. Blend it, bake it, and serve it up after a nasty two week sell-off and you have a great recipe for an oversold bounce.
We still have about two weeks left before results from Europe's stress tests on the banks are due to be released. We already know that markets hate uncertainty. Whether or not you believe these are accurate tests on the banks the results will still provide the impression of more clarity and transparency on the health of the European banking system. While I'm on the subject of Europe both the Bank of England and the ECB left rates unchanged last week. The BoE left rates at 0.5% and the ECB at 1.0%. For months now the euro has been the sentiment indicator for Europe. As investors worried about the health and future of Europe the euro plunged. Now the euro is rebounding although there is plenty of skepticism that this is just a massive amount of short covering driving this rally. After sinking to new four-year lows in June against the dollar we shouldn't be surprised to see the euro produce a prolonged oversold bounce. If this bounces continues I think we could see the euro rally towards the $1.30 level before running out of steam again.
Weekly Chart of the FXE euro ETF:
Chart of the FXE euro ETF:
The amount of economic news last week was pretty light. I mentioned the rise in Germany's exports for May. That is very encouraging but then again Germany is the EU's largest and strongest member. GDP growth had appeared to stall the previous quarter. If Germany can show that growth has restarted it will certainly help investor sentiment. In the U.S. we had the Wholesale Trade report for May, which came in at +0.5% versus +0.2% in April. This is suggesting the U.S. economy is still growing although lately for every report that shows growth there seems to be another that shows growth has stalled. On Thursday the financial media made a big deal out of the drop in weekly jobless claims. Initial claims fell -21,000 to 454,000. Economists were expecting a drop to 460,000. I don't see why this is significant since the weekly initial claims has been bouncing around the 450,000-a-week level for months. The four-week moving average is still very high at 466,000. The same report showed that continuing claims plunged -224,000 to 4.41 million. Unfortunately, I suspect this is due to workers that have exhausted their unemployment benefits and have now fallen off the list.
Several major retailers reported their June same-store sales figures on Thursday. The results were very mixed. A few managed to beat Wall Street's estimates but for the most part increased traffic in stores did not translate into increased sales receipts. Over half of the companies that reported their same-store sales figures missed their estimates. This is a little worrisome. June and July are clearance months for retailers with huge discounts. If consumers aren't parting with their cash when they're surrounded by 50% off sales, when are they going to start buying again? The retailers could be underperformers the rest of this year. Consumers are still nervous about their job security. Any revenues the retailers did bring in during the second quarter could see a decrease in margins due to all of the discounts. There is still a chance for this sector to beat last year's numbers because the comparisons are easy but once we get past July the year over year comparisons get tougher. Wall Street will be keenly focused on how the retail sector does in August as the back-to-school season ramps up.
If consumers aren't spending where is the money going? Nervous consumers tend to save more and we still have an elevated savings rate, which is actually healthy for the country longer term. It seems a lot of our discretionary income is going to pay down debt. The Federal Reserve announced that consumer borrowing continues to plunge. Economists were looking for a drop of -$2.3 billion in May. The Fed said borrowing fell -$9.1 billion and they revised April from +$993 million to -$14.9 billion. The trend in consumer borrowing has been down for over a year with declines in 15 out of the last 16 months.
Americans are paying down their credit card debts and deleveraging their personal balance sheets. This is very, very healthy for individuals but it makes it tougher on the country's economic rebound. You've heard it a thousand times, it is generally accepted that 70% of the U.S. economy is consumer spending. The more money we send to pay debts is less money to spend at the store. I can't give American consumers all the credit. Banks have been cutting credit lines and available credit for several months now.
Speaking of the banks, mortgage rates on a 30-year fixed loan fell to an all-time record low of 4.57%. Freddie Mac has been tracking rates since 1971 and this is the lowest on record. Interest rates were lower in the 1950s but mortgages were for 20 years back then. Unfortunately, residential real estate demand has fallen off a cliff since the tax credit expired. Anyone who was interested in buying a home probably rushed to get under contract before the deadline expired. Compounding the problem are the strict banking guidelines to qualify, which limits the number of consumers who can take advantage of these record-low rates.
The Mortgage Bankers Association said mortgage applications inched up from a week ago but are still down -35% from a year ago. The real estate market is going to struggle for a long time. The number of foreclosure filings remain near record levels and consistently come in at over 300,000 filings a month. One out of four mortgages in the U.S. are underwater and more and more consumers are choosing to walk away since it will take years before they have any positive equity again. For many Americans who would love to refinance at these low rates they can't because they have no equity in their house or they no longer qualify given stricter lending standards at the bank. According to one analyst the banks own more residential real estate than homeowners for the first time in American history due to years of elevated foreclosures. The Obama administration's HAMP loan modification program has been a failure with a high percentage of homeowners that do not qualify and an alarmingly high percentage of homes that are modified still going into default afterwards.
I do see a silver lining. There was (is) a huge worry that a significantly large chunk of adjustable rate mortgages will reset in 2010-2011 and the reset would send monthly mortgages rates higher, which in turn would further complicate the foreclosure problem. If mortgage/interest rates stay this low we could actually see mortgages reset lower! Cross your fingers that rates stay this low through 2011.
I would caution readers on the last week's market rally. Don't trust it. Stocks had reached oversold levels and this is just a relief rally. I warned you a week ago that any rallies we did see would probably be very sharp, which is typical for a bear market rally. Now officially we are not in a bear market but given the market breakdown in late June it is safer to operate under the assumption stocks will act like they're in a bear market. Technically the S&P 500 is bouncing from the 38.2% Fibonacci retracement level of the rally off the 2009 lows (see weekly chart below). I do not think it is a coincidence that the oversold bounce in so many sectors and indices has stalled near the 50% retracement of the prior two-week sell-off. In the absence of any fundamental news traders look toward technicals. That could change soon as earnings season approaches.
Weekly chart of the S&P 500 index:
Daily chart of the S&P 500 index:
Dow-component Alcoa (AA) officially kicks off the second quarter earnings season on Monday. AA reports after the closing bell and Wall Street is looking for a profit of 12 cents a share. AA typically disappoints. The companies to watch are Intel (INTC), J.P.Morgan Chase Bank (JPM), Google (GOOG), Bank of America (BAC), Citigroup (C) and General Electric (GE). INTC reports on Tuesday. JPM and GOOG report on Wednesday. BAC, C, and GE report on Friday. The following week the flood gates will open and we will hear dozens and dozens of companies reporting. Analysts are expecting Q2 earnings to rise +27.1% compared to +58.1% in the first quarter. Year over year comparisons should still be relatively easy to beat but Wall Street knows that. The bigger question will be, "did the company make a profit on improving sales or by cost cutting?" and what is their outlook for the second half of this year? Corporate America's guidance on the next couple of quarters could shed some light on our prospects for a double-dip recession or not.
Apparently the IMF does not believe in the double-dip scenario, at least not globally. The IMF updated their 2010 forecast and raised their estimate on global growth from +4.2% to +4.6%. This move is being driven by a strong Asia, the current rebound in the U.S. and some of the emerging market economies. It is worth noting that the IMF did point out that the European debt crisis still poses a significant risk toward global growth. What puzzles me is how the IMF can be so bullish. The U.S. weekly leading economic indicators are plunging. At the same time the Baltic dry goods index is also suggesting a severe drop off in shipping demand. If economic activity is so strong why do these two indicators look so bearish.
Chart of Weekly Leading Indicators
Chart of Baltic Dry Goods Index (close up)
Chart of Baltic Dry Goods Index (wide view)
On a short-term basis stocks will likely chop higher for the next week or two thanks to Q2 earnings. Obviously we will see lots of individual stock winners and losers as investors react to earnings news. Unless corporate guidance improves significantly I suspect we will see the market rally stall and roll over in the second half of July. That will set up for another decline into August where I expect the S&P 500 will retest the 1,000 level. If the 1,000 level breaks then the next area of significant support will be the 950 region.
LONGER TERM OUTLOOK
Previous Comments on my Long-Term Outlook:
My long-term outlook has not changed. I still expect the economy to see a double-dip, "W"-shaped rebound with the second dip in late 2010 (some analysts are predicting it will not show up until 2011). Lousy consumer spending, rising foreclosures, and lagging job growth will be the main culprits. Several weeks ago there were some comments out of the U.S. Treasury concerning foreclosures. The Obama administration's HAMP loan modification program can only help a certain number of homeowners and one official said that even if the HAMP program was a total success we should still expect millions of new foreclosures.
Estimates were in the 3 to 5 million foreclosures over the next three years but a White House advisor was quoted with estimates in the six to ten million range over the next three years. This only reinforces my own belief that we will see another tidal wave of foreclosed homes in 2010 and 2011. What is that going to do to consumer confidence and consumer spending? It's not going to help! You can review my long-term outlook here. It's the second half our my "Two Months Left" commentary.
~ James Brown