Last week I did not like the way things were shaping up. I expected to see continued strength from cyclical stocks as they posted good earnings and I expected to see strength in the financials once they demonstrated their lack of exposure to tightening credit markets. I believed those two events were going to rally the market to new all-time highs during option expiration week. The negative reaction from both groups told me that the market was in trouble. When I looked ahead at this week’s economic numbers I did not feel that there were any that might influence the market. In hindsight, that was fairly accurate. Housing numbers were the fly in the ointment. The market has become numb to the bad news from the sector and it had braced itself for more of the same.
The shock came when CFC, considered to be one of the sharpest lenders, hosted its earnings conference call. They described how loan defaults are spreading to other areas and the market panicked. CFC has been proactive in managing their risk and the market was shocked. As the week unfolded, the selling pressure increased. Once the market gained selling momentum the buyers pulled their bids. After a few air pockets, the bottom fell out Thursday. At its worst level, the market was down 50 S&P 500 points. It had small afternoon rally and that pared some of the losses. On Friday the market looked like it might fight off a number of attempts to push it lower. The bears got their wish in the last 30 minutes and once again, the bids disappeared going into the weekend. The drop felt like there were no buyers, as opposed to too many sellers. I won’t discount the move since it easily made its way down to a major support level at SPY 146. I did not expect that.
The magnitude of the decline this week was bigger than what we saw in February. In fact, this was the worst 5-day period since the year 2000. The market has new information that it needs to digest and it’s likely that this round of selling will take more than a few weeks to work off. The market will bounce and test support levels during the next two months before it settles down. Increased volatility will remain through September. Any attempt at a year-end rally will have to include the financials and tech.
Next week’s economic releases will include personal income, the PCE price index, Chicago PMI, consumer confidence, ISM and the Unemployment Report. The unemployment report is the most important release and it has been bullish for the market every month this year. A 4.5% unemployment rate and hourly earnings that are outpacing inflation are positive for the economy. I believe this report and end of month buying will support the market and rally stocks from an oversold condition. I’m not looking for the market to resume the rally; I just feel it will repair some of the damage.
These companies are slated to release earnings this week: APC, GEHL, HUM, MTW, MNST, RSH, VZ, TSN, VMC, AVP, BWLD, CAM, RIO, XRAY, MRO, MET, NVT, VLO, ANDE, CBI, CI, ERTS, GRMN, PH, SOHU, SBUX, TWC, TRW, ATK, AMT, RATE, CKP, EK, JSDA, RDC, WLT, PG, TM, WY.
If the SPY closes below 146, my bias will switch from bullish to a neutral. Earnings have been decent and interest rates are coming down. I feel U.S. stock valuations are reasonable and as a nation, we have full employment. These are all positives for the market.
That said, I do have some concerns. When money is loose, people get sloppy. That’s true for home buyers, bankers, builders, asset managers… Tightening credit markets remove inefficiency. American consumers are tapped out. We are entering our 27th consecutive month of a negative personal savings rate. This can’t go on much longer. Global equity risk exposure is also a real danger. No one really knows the magnitude of the yen carry trade. We can only hope that traders and brokerage firms reacted to the warning shot that was fired last February. As credit tightens, brokerage firms raise their margin requirements. If hedge funds have to reduce their holdings, that selling could spillover into our market. I also suspect that many emerging market equities are overvalued.