Following our latest economic outlook post, the S&P 500 fell 67 points to 879, plummeting through the 890-950 range that contained it for more than two-and-a-half months. Just six sessions later, though, it had soared higher to the top of the range. Since then, it has proceeded to continue riding momentum to a level of 1010. The question becomes whether the March-May run was the first leg of a new bull market, followed by a 10-week consolidation, and now the second leg of the bull. At this time, we do not foresee a new bull market; however, it is possible to see a fun summer rally for another 5 to 10%, especially given the amount of short-covering that is occurring from hedge funds. This is a traders’ market and we are continuing to take advantage of the volatility.
On the technical side, the following points in the S&P mark the most widely cited levels of overhead resistance, some which we just broke through today:
1000 is deemed “psychologically important,” just as it was on the way down.
1006 provides chart resistance from the early November high.
1007 is the 38.2% retracement line of the 1982 to 2007 bull market.
1008 sets off trend line resistance from the early May high.
1011 is a Fibonacci extension resistance based on recent consolidation width.
1016 is the 38.2% retracement line of this bear market, so far.
1150 marks the down trend line from the 2007 top.
If we can maintain a level above 1016 on the S&P 500, we could see Goldman Sachs’ near-term targets of 1050-1100 on the S&P 500 and 10,000 on the Dow. Should this occur, we would then recommend extreme caution, as the country will still be faced with the grim reality that when the rally is over the economic recovery will be going at a snail’s pace. Specifically, we feel there are still risks to overcome before the economy begins to fully recover, such as the diminished likelihood of near-term rebound in consumer spending, unsustainable profits based principally from corporate cost-cutting, the expensive and controversial health care package, increasing default rates of commercial real estate and consumer finance securities, and a slower than expected recovery in residential home sales.
Earnings season has shown us that companies have taken drastic actions to beat expectations and maximize profits. Unfortunately, the largest cost-cutting measure that has enhanced earnings is layoffs. In other words, while companies have typically had reduced revenues, their earnings are higher due to trimmed payroll expenses. These sorts of corporate earnings victories are not sustainable in the long-term and re-focus our attention to the most important figure to track, unemployment. Today’s unemployment report showed that 247,000 jobs were lost in the month of July, a vast improvement from prior months and better than most analyst expectations. Hopefully job creation is right around the corner, although most signs point to that occurring only once businesses feel comfortable about their outlook in a post-recovery economy.
On a related note, consumer spending, which accounts for two-thirds of domestic output, has taken a hit during the recession as individuals cope with the realities of decreased income and the need to increase savings. As a nation highly dependent on consumers for economic growth, it follows that the economy cannot fully recover without consumers recovering first. For that to happen, a drop in the levels of both unemployment and the underlying fear of unemployment are crucial.
While we are confident that the economy has stabilized significantly and made vast improvements from its gloomiest days of the economic meltdown, there are simply too many reasons to remain cautiously prudent and avoid getting caught up in the “irrational exuberance” of the market, especially if we reach Goldman Sachs’ target levels. Last week, second quarter Gross Domestic Product came in at -1%, which was slightly better than expectations. We are hopeful for the return of positive GDP for the third quarter with continued growth into 2010. In summary, if the upper ranges are broken we can take advantage of a further rally; however, signs of a slow recovery will eventually lead to a correction, especially when Congress is back in session. Such events, of course, would provide a good opportunity to protect your portfolio from the downside. The recovery is certainly an ongoing process and we will continue to provide updates on our economic outlook and investment strategies.
Filed under: Economy, Investments
