Mixed Signals

It’s time to do a little inventory of market signals, economic signals, and earnings signals to get a reading in the tea leaves on market and economic direction. Right now, the signals look mixed. I think it’s pretty easy to argue both a bullish and a bearish case. Let’s break up the individual signals to get a checklist going of the good and the bad starting off with the stock, bond, and currency markets.

Market Signals

Stocks

The stock market started a correction on April 26th. Since May 25th that correction has stalled near the February lows. The market traded slightly below those lows from June 30th to July 2nd, which caused many to say a head & shoulder (H&S) top had formed; however, two days later the market failed to achieve another key characteristic of H&S patterns, which is the retest. On July 7th, the market closed well above the H&S neckline with a close of 1060. A whipsaw or bearish trap had formed. The S&P 500 closed today at 1115, only 2 points away from the June closing high at 1117. With a break in the April trendline, there’s only one more barrier to breach—the 200-day moving average—which is currently at 1113.

In addition to the failed H&S top, I’ve been watching Fibonacci retracements and breadth to determine the health of the current July rally. In previous rallies, the bulls have failed to move the soccer ball back into the bears’ side of the field as evidence the bears had full control over the stock market (see my July 12th article "Volume, Fibonacci, and Soccer"). As of today, the S&P 500 has virtually retraced 100% of the June correction with an intermediate signal that bulls are regaining control of the ball.

Breadth has improved tremendously with three accumulation days and only one distribution day since the July 2nd low. Despite I’m only showing three accumulation days, the NYSE advancing issues have remained above 2/3rds of the NYSE board, eight out of the last fifteen days while NYSE declining issues have only reached above that level two times.

In addition, the percentage of stocks trading above the 50-day moving average has moved well above the percentage that traded above the 50-day moving average at the last high on June 18.

In summary, market internals have improved tremendously since the July 2nd low.

Bonds

Bond prices have rallied since interest rates started falling on April 6 for the 10-year Treasury Note. U.S. Treasury yields fell just as investors turned to the U.S. Treasury market amidst rising European credit market risk. Interest rates have been in a declining trend since April but appear to be forming a low…

just as credit market risk indicators have eased in the last month.

Currencies

There are three currency relationships I’m watching. Starting off with the Euro / U.S. Dollar, a 5-wave move in the euro had finished in June with a declining trendline break in July. The intermediate trend has been bullish for two months now since the June low. Many said, "Good-night, sweet (Euro); And flights of angels sing thee to thy rest" since it fell below $1.32 in April, but few have talked about its June/July resurrection.

As the euro is 56% of the U.S. Dollar Index , one would expect the U.S. dollar to have a difficult time while the euro was rallying. Normally, it has been very bullish when the U.S. dollar has fallen for gold; however, gold has fallen $72 since June 25th. With both the U.S. dollar and gold in decline during June and July, it appears as though the safety-trade is taking a break.

The last currency relationship I want to focus on is the risk-trade, or the euro / Japanese Yen. Over the past decade, investors have been able to borrow the Yen cheaply and invest in commodities and the Euro. That trade largely unwound in 2008 but also has appeared to do so in 2010. Since late May, the Euro / Japanese Yen has been basing, but a breakout has been lacking. Until I see a breakout, it doesn’t appear to me that the risk-trade is quite on yet.

Economic Signals

Fiscal stimulus in 2009 and inventory restocking in 2010 have all helped to push many economic indicators into expansionary readings; however, some of that momentum appears to be leveling off. Starting off with the Economic Cycle Research Institute’s leading economic indicators (LEIs), my brother, Chris Puplava, discussed last week that the LEIs are forecasting weaker economic activity ahead with a year over year growth rate that has dipped below 0.

The ISM Manufacturing Index appears to be rolling over; however, a reading above 50 indicates the manufacturing base is expanding. Anything above 43 indicates slow growth while the manufacturing sector is contracting. Anything below 43 indicates recession. The last reading was on July 1st at 56.2, declining 3.5 points from the May announcement.

Retail sales have declined for the past two months, but two months isn’t enough to write-off the economy. Almost 75% of the time the change in monthly retail sales is between +1 and -1%. The year-over-year change tends to smooth out the large effect that a good month in auto sales can have on the indicator. That average has rolled over as of late; however, it’s still positive.

Jobless claims have leveled off over the past nine months from a large decline in 2009. The economic indicator ticked up for the week of 7/17; however the reading is rather murky due to holiday distortions and retooling in the manufacturing sector. The main point here is that jobless claims have been flat.

Overall, economic indicators are pointing towards slower growth. Fiscal stimulus and inventory restocking have pushed sales and manufacturing into positive territory over the past year. The momentum from both of these steps to stimulate the economy seems to be waning. As I wrote in January this year, the real question is whether the consumer can shoulder the burden of growing the economy, and that is dependent on two factors: asset valuations and income. You can’t have income without a job, and you don’t feel able to spend money if your house and 401k are in decline. There was a decent drop in Consumer Sentiment for July, but the indicator has mostly been on the rise since April 2009. If the Stock market and job market resolve to continue their recent decline, the consumer may not be able to shoulder the weight of the economy.

Earnings

The earnings season continues this week with over 1,000 companies scheduled to announce and an additional 1378 more to announce into August 9th. Now, the market rallied in advance of the start of earnings from July 2nd to my last article on July 12th, up 72.76 points or 7% (1022.58 to 1095.34). Since July 12th, when Alcoa reported a gain after the market close, the market has been up another 19.67 points or 1.8% (1115.01 from 1095.34). So the gains in the stock market have largely been achieved due to a bounce back rally from an oversold condition and not from the earnings season; and that’s despite over 75% of the S&P 500 surprising Wall Street estimates, thus far. We still have two more weeks of earnings season.

Below is a historical look at the percentage of S&P 500 companies that surprise Wall Street dating back to the early 1990’s. Notice the trend? Seems to me the measuring stick is kind of low.

Percentage of S&P 500 companies surprising analyst estimates

Source: Bloomberg

Summary

The stock market has rallied in advance of the earnings season from an oversold condition–nothing out of the usual here. The earnings season hasn’t told us much other than that the bar was set too low as usual. The only company releases that have really attracted my attention have been bullish remarks from Freeport-McMoRan (FCX), Caterpillar (CAT), and Airbus. In summary, they said that copper, tractors, and airplanes are selling well. Most companies don’t plan to buy heavy industrial equipment, stockpiles of copper, or billions of dollars on busses with wings unless long-term prospects look good.

Other than the ECRI’s LEIs which are pointing towards recession, all of the other indicators are pointing towards slow growth. As I wrote in January, inventory restocking and government stimulus have gotten us this far. It’s now up to the consumer to shoulder the economic yoke. Unemployment (and under employment) have been stubbornly high. Consumer income and spending won’t be released till next week to get a fresh look, but they’ve been rising each month since November 2009.

The financial markets have been flat now for over two months with massive volatility. If you’ve been trying to plan some long-term strategies, technical, economic, and momentum indicators have probably put you through the wringer. I like what Ned Davis had to say recently in this environment that he’s trying to "do no harm" with a neutral position on the market. He’s been right on for the past two months in which the market has been in a large trading zone. In my opinion, the bulls have swung the pendulum in favor of their side since we broke above the 50% Fibonacci retracement, the declining trendline (from April), and the 50-day moving average. On an intermediate-term basis, we have a higher low and a confirming higher high on both the Dow Jones Transports and the Dow Jones Industrials today.

There are a lot of positive indicators swinging in favor of the bulls of late.