It was set to be a quiet, short week. The markets had already rallied 5.5% from the week previous. What more could the market do after 5 straight session gains? Two major scheduled events hit the tape today including the ADP jobs report (which attempts to estimate in advance changes in the monthly Bureau of Labor Statistic’s employment numbers) and the European Central Bank meeting. The market responded positively to both events with an immediate reaction in risk-on assets.
U.S. Economy and EU Headlines
The ADP private employment showed month-to-month strength estimating a 157,000 gain versus a revised 36,000 gain in May. Mind you, this data is missing the government job portion we’ll get from the BLS report tomorrow. In addition to the ADP report, unemployment claims dropped 14,000 to 418,000. The U.S. dollar rose in the morning due to the data, but gave back gains after more headlines from Europe.
Those headlines included the 25 basis point hike to 1.5% which is still considered accommodative according to the ECB. Investors were expecting a hike due to the “strong vigilance” communication from Trichet last week regarding inflation; however, it was the communication behind the hike that was most influential on the euro. Comments from Trichet have led analysts to assume there will be more rate hikes this year before Trichet retires this October.
Trichet said, “it is essential recent price developments do not give rise to broad based inflation pressures over the medium term.” When asked about the peripheral nations, he said “I have a lot of questions on Ireland, Portugal, Greece…Shall I remind you that we’re responsible for price stability for the euro area as a whole. Those issues which you’re addressing constantly (peripheral economic weakness) should be addressed to governments, they’re responsible.”
In addition to the rate hike and hawkish comments from Trichet, Portugal was a main topic. Trichet stated that Portugal has approved an economic and financial adjustment program that the EU, ECB, and IMF agree with. He also stated that the ECB will suspend its minimum credit-rating threshold on Portuguese bonds after Moody’s lowered their debt to junk status on Tuesday. The ECB has done the same for Greece and Ireland. The stock market acted barely interested to the downgrade earlier in the week, a sign of a more bullish market.
Sub-Drivers
Debt Ceiling
Analysts have been wondering whether debt ceiling risk would come to the front of the table as some elements of European sovereign debt issues subside as it pertains to investor psychology. It seems the debt ceiling continues to be in the background of market focus but many now view the outcome in a positive light. Most macro economists believe:
- There will be an extension or expansion of payroll tax cuts
- A corporate overseas repatriation holiday
- A larger $4 trillion deal from both parties could be in the works
Financials
In addition to positive economic data, banks have seen some regulation headwinds subside over the past two weeks. With the Bank of America settlement last week, the Sifi announcement placing capital requirements near 2.5% (less than expected), the Fed rate cap on credit cards (less than expected), and the mortgage foreclosure settlement (expected next week) could come in lower than expected by the NY Post article yesterday (they corrected their estimates lower today). JPMorgan and Citigroup will post earnings late next week and should be the driver on this sector following last week’s events.
Possible End to China’s Restrictive Policies
The PBOC raised rates Wednesday morning, but many feel that we should soon see a change in policy going forward as growth slows and inflation peaks. Citing comments from Premier Wen Jiabao a couple of weeks ago, “China has made capping price rises the priority of macroeconomic regulation and introduced a host of targeted policies. These have worked.” Additionally he said, “The overall price level is within a controllable range and is expected to drop steadily. The output of grain, of which there is now an abundant supply, has increased for seven years in a row. There is an oversupply of main industrial products. Imports are growing fast. We are confident price rises will be firmly under control this year.”
If prices are firmly under control and there’s ample commodity supply, it is growing less likely that China will need to continue to raise rates. This may serve to stimulate Chinese equities and commodities as China’s two years worth of restricted policies may be coming to an end.
Technology
JPMorgan upgraded hard drive companies: Seagate Technology (STX) and Western Digital (WDC) which helped tech overall. This caused industry groups like semiconductors to outperform the market with the SMH ETF up 2.39% today. Within handsets, Samsung’s second quarter update was good but LG Electronics added to Research in Motion and Nokia’s negative highlights from weeks prior.
Retail
The leading industry group today was clearly retail, with the S&P Retail SPDR (XRT) up 2.65% today based on a stronger than expected same stores sales data today. The upside surprises came out of Target, Kohl’s, Dillard’s, and Gap. Urban Outfitters was up 5.96% after Morgan Stanley upgraded them.
Technically Speaking
S&P 500
The S&P 500 drove right through a major supply zone today at 1340-1345. This zone had repelled advances in the past such as in February 18th, April 6th, and May 31st. The next resistance zone is the April highs near 1370 that were achieved the last time 1340-1345 was breached. 1370 represents an extreme supply zone that should rebuff an advance on the first take; however, this advance has an incredible amount of pent up momentum behind it powered by economic acceleration and resolutions out of Europe regarding sovereign debt that stand to support a bullish slant in the markets.
U.S. Dollar
The U.S. dollar continues to trade sideways, oscillating between 74 and 76 on the dollar index. It hasn’t broken down and it hasn’t broken higher. The 50 DMA (50-day moving average) is essentially flat at 74.76. It’s impossible at the moment to certifiably determine the next move in the dollar, up or down, but a break above 76 or a break below 73 would help. Positive economic data could strengthen the U.S. dollar; however, the prospect of more rate hikes out of Europe will widen the interest rate differential. Positive sovereign debt developments in Europe and a wider interest rate differential (between the ECB and the Fed) will steer investment into the euro. With strength in the euro and in the U.S. economy, it is tough to say which driver will steer the dollar, lower or higher. The dollar looks to be in a triangle or continuation formation, but I could probably also argue that it’s in a bottoming process as well with a significant demand zone near the 2008 lows. Look for a break in the nearby consolidation soon to resolve this long-term question.
Commodities
Until the dollar resolves its near-term consolidation, I’m hesitant to call for a bullish reversal in commodities. As I explained a couple of weeks ago, the CRB index broke down and confirmed a negative trend reversal per technical analysis factors with a lower high in June under the 50 DMA and a close below 336 – support for the past four months. Despite the technical reversal pattern, I explained that the index was still holding above its 200-day moving average and the break below 336 happened above the 200 DMA. As such, I reserved a topping call until we saw a clear break below the 200 DMA – of which we didn’t get. It closed on June 27th below the 200 DMA, but not by a large margin – which is typically greater than 1-3%. There was no follow through and the CRB closed back above the 200 DMA on June 28th, back above 336 on June 29th, and above the 50 DMA today. The technical pattern still suggests that the CRB has topped, but my hesitancy has been confirmed by the three key technical earmarks listed above (again: above the 200 DMA, above 336, and above the 50 DMA). The CRB index and commodities as a group will be further supported by a close above 352, a breakdown in the U.S. dollar, and/or stronger economic indicators.
Bonds
The bearish divergence I warned about in Treasuries two weeks ago has been confirmed over the past two weeks by a breakdown in price and trend. The 30-year Treasury broke its short and intermediate trend, but the long-term trend is intact. So far, the RSI is holding bullish support levels near 40. For the long-term trend to be changed, a rally will need to be rejected at 60 on the RSI and/or by a flat to falling 50 DMA.
(Small addendum on bonds)
There was positive news today for municipal bonds when Reuters released a report showing U.S. states have beaten withheld tax forecasts. The report stated that budget turnaround is picking up pace. Additionally, late on Thursday, Standard and Poor’s raised its outlook on California from negative to stable saying “The negative outlook had been linked to the possibility of recurring cash deficiency that we now believe the enactment of the fiscal 2012 budget is likely to mitigate for the most part…the state has improved the structural alignment between its recurring revenues and expenditures.” You can read the story here. Muni bonds have been recovering nicely in 2011 since the great supply dump and the end to the Build America Bond program in late 2010. The recent news should further support that trend.
