Optimism Sliding

It’s Sunday!  We made it!

Yeah, the ‘end of the world’ came and went with few catastrophes.  The only notable Mother Nature event noted was a fairly significant volcanic eruption in Iceland.   But, it looks like mankind will go on for now and you’ll still have to pay your bills.  Eventually, we’ll kill the planet or each other and I assume both will happen long before a meteor hits us or the sun explodes.  If’ you’re ever interested in understand how we’re destroying our own planet inch by inch, watch “X-Ray Earth” on NatGeoTV. It’s sad that a group of people received so much attention about yesterday’s predicted demise while the real issues we have on this plant go virtually unnoticed.  I guess it’s harder to face the truth.  We’re fighting over space on the couch while the house is on fire. Ok, I digress.  I won’t use this space to get on my soap box 🙂

Back to the markets..

Friday didn’t feel very good and it’s easy to see fear is finding its way more and more into the markets.  Right now, I wouldn’t call it fear, but would definitely classify it as reduced optimism with increasing levels of caution.

The clues:

1. What has lead the market up to this point?  Well, most would say QE2 and the overall monetary policy tossed out by Ben and team.  The policy encourages the Goldman Sachses of the world to put money in the markets and take on risk trades while at the same time destroying the dollar. The obvious place to put money was in commodities.  When you look back, it can be argued that strength in commodities and the falling dollar was the back bone of the move since March, ’09.  With QE easing and possibly going away, the dollar may actually strengthen (we’ve seen some signs of this lately) and destroy the commodity trade (we’ve already experienced this). So, what’s going to push the market up from here?  That’s the million dollar question that I’m not sure we know… thus, fear.
2. Sectors and stocks with strength throughout May are showing signs of fear in the market and a general slowdown.  The stocks (generally) with the most consistent strength seem to be non-cyclical and are based on everyday life – tobacco, toothpaste, utilities, etc.  I call them recession stocks.  This also includes low cost clothing stores and companies like Dollar Tree.
3. Understanding U.S. consumer demographics and how they are influenced by the market is a great way to look at developing trends, as well.  High end apparel continues to do pretty well, while the middle of the road (Gap Stores, for example) are starting to falter.  The lower end of the apparel sector is doing better than the middle.  Easy translation – Middle America is being squeezed and many are starting to spend down, thus the relatively good strength in Costco, Dollar Tree, 99 Cents Store, Dollar General, BJ’s Wholesale Club, etc.   Keep an eye on the high end retailers.  Weakness here will show that the least affected group by market fluctuations (high income) are starting to spend less.  When the top turns over, it’s going to get ugly.
4. The data…
   1. Initial Jobless Claims.. Sure, it has dropped 2 months in a row, but we’re still at levels seen at the beginning of the year.  Government backed ecomonic stimulous was based on the general idea that if the gov could get enough people temporarily hired (through gov contracts, etc), then that group of people would spend.  The spending would cause hiring to keep up with demand.  The hiring would create more buyers.. and the trend evolves.  Some argue that the stimulous was actually not big enough, thus not kicking in the cause and effect engine hoped for.  It’s up for debate.  But, what we do know is that what’s ultimately transpired is an increasing government debt without improving employment or wages.
      
   2. Employment – Non Farm Payrolls have been consistent over the last three months.. that’s good, but the yearly % appears to be trying to roll over.  The next report will be telling.  The uptick in the unemployment rate might be foreshadowing the market melt in June that I’m anticipating (hope I’m wrong). The Gallup Unemployment chart (last one) shows a slightly more optimistic view, but also confirming the recovery is slow, at best.
      
   3. Industrial Production: Numbers are not so pretty here.  I’m watching the Phili Fed Survey to see it if can stay in this upward channel or if we’re about to break through the bottom.  The CB Leading Indicators Index (second chart) measures overall economic health by combining 10 indicators such as building permits, new orders, money supply, average workweek.  Producer Price Index is also showing the pressure on producers.  These pressures make it very difficult to hire or raise wages.
      
   4. Consumer Data – CPI drifting up. Not sure how this can help economic growth.  The Consumer Sentiment improvement can largely be explained by consumer’s optimism that gas prices will drop following crude prices.
      

In summary, we’ve implemented various economic recovery efforts starting with measures by Bush at the end of his term followed by additional policies by Obama.  The bottom line is that it’s moving much slower than we all had hoped.  The stock market is not a good reflection of what’s happening as it is a manipulated engine and hides the fact that we’re still at 9% unemployment and there are slowing signs in production and global growth.  Where we go from here is not know, but the likely path, in my opinion, is down before up.

As a traders, I normally don’t concern myself too much in the macro picture, but it helps me assess risk management and where money is flowing.  Right now, I’m personally waiting for a healthy pullback before I load up on too many longs.  Until that happens, I’ll spend most of my time trading intraday.  However, the one thing that has changed is that I’m starting to screen for short setups.  I don’t think June will be pretty, but we live in a global economy, so anything can happen.  Stay nimble and close to your trades.  Avoid emotion and play what’s in front of you.

Happy trading and see you tomorrow.