Stocks Climb in September
Equity markets rebounded last week, while fixed income markets sold off. A mixed jobs report on Friday capped off a mostly positive week of economic data. For the week, the S&P 500 rose 1.40%, while the Dow advanced 0.8%. The Barclays Aggregate Bond index fell 0.86% as the yield on the 10-year Treasury rose 18 bps during the week to 2.94%. Rates are at their highest levels since mid-2011.
Abroad, major central bank meetings took place in England, Europe and in Japan. Each bank stood firm on policy, despite green shoots of economic growth in Japan and Europe. Europe recently emerged from recession, while Japan is seeing the desired impact of its aggressive easing program. Inflation is rising at the fastest pace in five years in the country, while corporate investment and overall growth is also improving. New Bank of England head Mark Carney noted that the bank does not plan to increase rates until unemployment falls to 7%, a level not expected to be reached until 2016.
On Tuesday, the Institute for Supply Management (ISM) reported that its benchmark-manufacturing index advanced to 55.7, a surprising climb given the prior month’s spike. Most analysts expected the series to normalize somewhat after the robust July reading. Softness in regional manufacturing surveys had also foreshadowed a less-than-stellar result for August.
The encouraging component of Tuesday’s report was new orders, which followed up a 6.4 point gain in July with a 4.9 point rise in August. Strength in new orders often portends future strength in this index. At 63.2, new orders are at their highest level since early 2011.
ISM released its other important measure of economic activity on Thursday via the non-manufacturing index. The indicator climbed to 58.6 in August, suggesting a 44 straight month of expansion in the US service sector. According to ISM, this is the highest reading since the index’s inception in January 2008. Strength was evident across the index, with all but two component indices advancing in August.
On Friday, investors were met with a very mixed employment report. Although the unemployment rate fell another tenth to 7.3%, this was mostly due to a decline in participation by workers. Additionally, nonfarm payrolls came in under expectations and the prior two months were revised sharply lower. Following an initial drop, equity markets climbed back to breakeven for the day as investors hoped the news would delay any Fed tapering.
In the establishment survey, nonfarm payrolls rose 169,000. This was 6,000 below consensus, and below the pace of 184,000 observed in the prior 12 months. Of more concern, however, was a collective 74,000 downward revision to June and July. July, in particular, was revised to a very tepid 104,000 gain. August’s new jobs were concentrated in retail trade, health care, and leisure & hospitality (led by food and drinking places).
In the household survey, the aforementioned dip in headline unemployment was accelerated by a two-tenths drop in the labor force participation rate. At 63.2%, the labor force participation rate is at its lowest level since 1978.
One encouraging takeaway from August’s labor report was a noticeable drop in the underemployment rate, or U-6 measure. As we often note here, this metric is considered by some to be a more accurate representation of unemployment as it accounts for marginally attached workers and part-time workers who prefer to be full-time. The U-6 indicator fell from 14.0% to 13.7% over the month, and is a full point better than 12 months ago.
Market Technicals Signal Trouble Ahead
Bear market enthusiasts have so far been disappointed in September after the sudden market rally last week. With equities up more than 1% on the month, many bears pointed to the historically poor performance of equity markets during this month as a reason to remain cautious. Bear enthusiasts need not fear, as markets appear to be converging toward an inflection point right around the Fed meeting in the middle of the month.
Through the end of August, the 50-day versus 200-day exponentially weighted moving average (ema) of the S&P 500 index remained bullish. The 50-day ema crossed above the 200-day ema on January 5, 2012, and since that time, the S&P 500 experienced a total return greater than 27%.
At the end of August, the S&P 500 was 1.5% below its 50-day ema, 3.5% above its 200-day ema, and the spread between the two metrics narrowed to 5.1%. It would take a one percent loss for 18 consecutive trading days to produce a sell signal by causing the 50-day ema to fall below the 200-day ema.
While this crossover indicator remains bullish, deteriorating internal momentum and breadth indicators suggest that the market has not fully corrected yet. Similarly, given the market’s dependency on accommodative Fed policy, a breakdown of relative strength in the financial sector is a troubling development that may portend more significant declines for the broader equity markets.
Equity markets corrected from the top of their respective price channels in August on the combination of rising interest rates and Middle Eastern geopolitical fears. The S&P 500 fell 2.9% in August to 1,633, 4.5% below the all-time high of 1,709 achieved on August 2. Both of the major Dow Averages lagged, with the Industrials falling 4.1% and the Transports declining 3.1%. Leadership from small cap stocks dissipated with a 3.2% drop in the Russell 2000 index, but the Morgan Stanley Cyclicals index fared slightly better with a decline of 2.5%.
August 15 marked a significant turning point for the US equity indices. The combination of weak earnings guidance and increased expectations for a September tapering of QE pushed the S&P 500 back below its 50-dayema for the first time since early July. Similarly, the 10-year Treasury yield rose to a new 52-week high and implied volatility broke out from depressed levels. Since then the S&P 500 has consistently confirmed resistance at the declining 20-day ema while making a series of lower highs and lows. The S&P 500’s unfilled chart gap from August 15 at 1,685 is likely to represent a key resistance level on any subsequent rebound.
Generally speaking, growth-sensitive areas of the market fared reasonably well, while higher yielding investments lagged significantly. However, one notable change in leadership that bears further monitoring occurred in the financial sector. The S&P 500 Financial sector declined 5.2% in August, the second worst performer behind only the Utilities sector (-5.5%). The sector broke through several critical support levels and performance relative to the S&P 500 broke down from an uptrend that had been in place since November 2012. The Financial sector has been the best performing sector over the last 12 months as the equity markets have continued to rally, and this breakdown in relative strength may be a warning sign of a deeper correction in the broader markets.
Internal momentum readings for the S&P 500, including the Relative Strength Index (RSI) and Moving Average Convergence-Divergence (MACD) indicator, both reversed from overbought extremes at the end of July and quickly declined into bearish levels. As is often the case, this deterioration of internal momentum preceded price declines in the equity indices. Broadly speaking internal momentum is not yet showing the signs of capitulation that typically precede a rebound in price.
Long-term market breadth indicators are continuing to weaken from prior bullish extremes. While extremebreadth readings can persist for extended periods of time during strong market advances, steady deterioration in these readings from the extremes typically precedes more substantial declines. Short-term breadth readings (such as the percent of stocks trading above their 20-day moving average) have declined to capitulatory extremes and may portend a rebound in early September, but the longer-term weakening in market breadth suggests that any short- term bounce should be viewed skeptically.
Potential support within the ongoing bullish channel ranges from 1,583 to 1,592 when projecting out a month, while long-term trend-line support off the lows since 2009 lies between 1,482 to 1,497. On the upside, resistance is likely to be challenged at the August 14 gap at 1,685 before any resolution higher. One way or another, the market appears to be heading toward a major inflection point around the time of the Fed meeting on September 18.
the week ahead
There are a few reports of note this week. On Tuesday, the National Federation of Independent Business releases its monthly small business optimism index. On Friday, investors will receive information on producer inflation and retail sales.
In Europe, two high level meetings take place this week: the Eurogroup Meeting and ECOFIN, a gathering of regional finance ministers. The continued integration of the European Union will certainly be part of the agenda. No major initiatives are likely, however, until after German elections later this month.
Central banks meeting this week include Serbia, New Zealand, Indonesia, Korea, Philippines, Chile, Peru, and Russia.
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