The Dow Jones Industrial Average snapped a four-week winning streak by losing 0.5%, while the Standard & Poor's 500 slipped 0.6%, and the NASDAQ Composite Index gave back 0.7%. The market has been well overdue for a correction or pullback, and the small losses of last week have probably done little to relieve the market’s overbought condition. The resiliency of the market in the face of its overbought condition is a sign of strength.
Last week was chock full of economic news. The Federal Reserve concluded its two day meeting on Wednesday and left interest rate policy unchanged. The Fed’s statement was not too much of a surprise and very similar to their previous statement. The Fed upgraded its economic outlook to “leveling out” from “the contraction is slowing” and they characterized recent activity in financial markets as having “improved further” from “generally improved.”
The most important takeaway was the Fed's decision to gradually slow the pace of Treasury purchases and to be finished purchasing the full amount ($300 billion) by the end of October. The Fed gave no indication that it will be contemplating new purchases. The ultimate result could be upward pressure on Treasury yields, as a major buyer will be removed from the market.
Other economic news showed the consumer remains under stress. July retail sales remained soft and confidence among U.S. consumers unexpectedly fell in August for a second consecutive month as concern over jobs and wages grew. The Reuters/University of Michigan preliminary index of consumer sentiment decreased to 63.2, its lowest level since March. On the positive side, a report from the Federal Reserve showed that industrial production rose 0.5% in July, the first increase in nine months, after mid-year retooling at automakers and the “cash-for-clunkers” program helped spur demand for cars. As we move into the second half of the year manufacturing output is expected to continue rising as companies restock depleted inventory levels.
On Thursday, on interview on CNBC, I said that I believe the economy made the transition from contraction to growth at mid-year and I expect the economy to grow 3% in the second half of this year. Others seem to be subscribing to that view as well. A Bloomberg News article this weekend stated the following:
The worst recession since the 1930s has created a reservoir of demand that will buoy the economy, say a growing number of economists led by James Glassman at JPMorgan Chase & Co., former Federal Reserve Governor Laurence Meyer and Stephen Stanley at RBS Securities Inc. “Whenever we have plunged off a cliff and fallen into a deep hole in the past, for a while the economy has a tendency to bounce back very quickly,” said Glassman, a senior economist at JPMorgan in New York. Glassman and his colleagues this month said forecasts of 3 percent to 4 percent growth in coming quarters may be too low given “pent-up” consumer demand.
While the U.S economy is expected to expand in the coming quarters, several European economies are already in growth modes. Last week the European Statistics Office reported that the GDP of the 16-country euro-zone fell only 0.1% in the second quarter. However, France, Germany, Greece and Portugal posted 0.3% GDP growth last quarter, much better than the 1.0% decline in U.S. GDP. In addition, the Bank of England delivered a robust forecast for the British economy for the rest of this year and into 2010.
This upcoming week has a full economic calendar but only a couple of reports that will have any impact on the market. The producer price index and housing starts reports on Tuesday will be closely watched, followed by the Conference Board’s Leading Economic Indicators and the Philadelphia Fed Manufacturing Index on Thursday and existing home sales on Friday.
Trading is likely to be light for the next couple of weeks as the end of summer draws near. The market has lost some of its upside momentum, but that appears to be caused by buyers stepping aside rather than outright selling pressure. The market is overdue for a correction. Investor sentiment has gotten a bit too optimistic on a short-term basis. The American Association of Individual Investors (AAII) sentiment poll showed that 51% of individual investors are bullish, that is the poll’s highest level since May 2008. In addition to the overbought technical condition and sentiment, September is historically the worst month of the year for the market. Combined together these factors argue for at least a pause that refreshes. Near-term support is 950 on the S&P 500 and as long as that area holds, the market will remain in a defined uptrend.
K. Sean Clark, CFA, is the chief investment officer of Clark Capital (www.ccmg.com).
