We were backing off of the high end of this trading range prior to this latest rally as the broad market fell for four straight weeks, but the 11% surge in the last 10 sessions has put in a new upper level as we are just 2.5% from the Election Day mark of 1005.
The only interruption to last week’s rally was a fractional decline on Wednesday and it doesn’t look like much will get in the way of investors’ desire to push this market higher, we’ve got people worried about missing out and that means new money is likely to keep moving in for a while still. We’ve got a big week ahead of us though and with $200 billion in Treasury issuance – who would have thought we’d be talking about such numbers in one week’s worth of auctions just a year ago? – and these events will be met with heightened anxiety; all it takes is one auction to go bad.
Health-care and utility shares led Friday’s advance – strange for these two areas of safety to lead the way when the bulls are running, maybe the wall the two consequential pieces of legislation ran into last week (health-care and cap & trade) played a role. It may have also been the move lower in the latest consumer sentiment reading that caused a move back to safety – one never knows on a day-to-day basis. Tech shares were the worst performing sector, which pushed the NSADAQ Composite to its first loss in 12 sessions.
Market Activity for July 24, 2009
And speaking of which, on Friday we talked about how the gridlock over the health-care legislation is the best news we’ve seen in a long time. Yes, the leading indicators index is pointing up, 77% of earnings results have beat estimates and home sales and housing starts are on three month upswing.
But hang on, these positives data readings could end up fooling people into a false euphoria – and recall we’ve talked about being aware of a euphoric trend as we begin to see things improve. The problem is we’re very likely headed for a statistical recovery rather than something more sustaining. The leading indicators are being led by interest rate spreads, but this misses the low demand for loans, and housing starts, which one cannot expect to last due to the supply glut, so I would be cautious of this LEI index.
Additionally, the better earnings results (another factor in LEI) are based upon very low-bar hurdles – profits are down 25% from a year ago and revenues have been hammered, which shows the lack of final demand. Let’s not get ahead of ourselves here, stocks are up 47% from their 12-year nadir hit on March 9 and the troubles in consumer-land will pressure growth.
We also have actual home sales looking better over the last three months and it certainly looks like housing has stabilized. But can we count on continued gains with the consumer de-leveraging process far from done and higher tax rates (expectations that after-tax incomes will fall) and a poor job market will not help this situation. Until this works its course, it’s tough to see a sustained housing comeback, just yet.
(We received the latest consumer sentiment reading on Friday, which declined for the first time in four months. The University if Michigan’s Consumer Sentiment survey showed that consumers believe the economic freefall is over but are now focused intensely on a weak job market and the unlikely prospect of income growth. The percentage of respondents reporting income gains was the fewest in the survey’s history, which goes back to 1966. Plans to buy homes, autos and durable goods declined as well. The consumer remains the big issue. Businesses are holding back, delaying spending plans too, but personal consumption makes up 70% of GDP. Until the labor market improves this will be a significant drag on growth. We should see a couple of quarters of good growth in 2010 as nearly a trillion dollars in government spending kicks in. This will likely be able to offset the weak consumer activity but only for a short while.)
But the rebuff on the Obama (actually the Pelosi bill as she’s been more instrumental in writing it) health-care plan is a really good sign and it also looks like gridlock is helping on the other destructive agenda – cap and trade. Now let’s hope the administration doesn’t shift its focus to pushing through another one of their stimulus plans – this will not help the corporate outlook. Businesses know that the more the government spends, especially with regard to the current degree of outlays, that this will have a crowding out effect as capital is sapped from the private sector – the true area of growth.
It appears we may not get the worst some (including myself) had worried about in terms of policy, but even if national health care and C&T are dead we’ll still get massive deficits and debt issuance, higher tax rates across the board, and a regulatory regime not seen since the 1970s. We’re now back to 16 times earnings on the market now – valuations are reflecting that the worst by way of policy may not occur. But from here the market will need real structural economic performance and we are quite a way from there at this point. So my message, as has been the theme since returning to 900 on the S&P 500 on May 4, is to continue to be careful here, don’t increase risk by chasing this rally.
Have a great day!
Brent Vondera, Senior Analyst
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