Don’s Outlook 7/16/2010
Over the past two weeks, I have discussed the growing divergence in valuations between stocks and bonds, even when viewed from a historical perspective. The fact that bearish sentiment had moved to extreme levels and the percentage of stocks below their 50-day moving averages had returned to the levels of early 2009 were other signs that a reversal was in order.
So it did not take much in the way of positive news to lift the gloom and doom from the stock market. Slightly better employment numbers and still healthy non-manufacturing readings from the Institute for Supply Management (ISM) data seemed to be enough to spark a multi-day rally that continued this week and reversed most of the losses from June, but it was not enough to break the downward trendlines that have developed on the charts.
There has been much technical chatter about a potential head-and-shoulders top formation and a recent “death cross” from the 50- and 200-day moving averages, which occurs when the former crosses beneath the other, preferably when both are declining. However, whenever such signals are widely quoted in the press, they are often discounted by the market as a whole. There were similar calls for a head-and-shoulders top formation to usher in a new bear market one year ago, yet stocks in aggregate proceeded to climb another 38 percent, proving that technical analysis needs to be balanced with a healthy dose of fundamental consideration.
Right now, the fundamentals have shown evidence of slowing but not turning down for good. Although global manufacturing PMI slipped in June, it remains squarely above its long-term average of 51.6 since 1998. And at 55, the monthly reading still sits in expansionary territory and is supportive of healthy growth in U.S. gross domestic product. This week, the release of the Federal Open Market Committee (FOMC) meeting minutes provided some insight to the disappointing data that stalled the market between the April and June meetings. While committee members’ economic outlook softened somewhat, they remained cautiously optimistic. Given that inflation trends have fallen to decade-low levels, some even cited the risk of deflation and the potential for another round of policy stimulus should conditions warrant it.
Another earnings season got underway this week, and so far the results have been positive. Although analysts expect that the first quarter probably represented a peak in earnings growth, the second quarter could still grow by 30 percent. The number of companies who beat expectations and provide higher forward guidance, however, could be lower.
