The Past Week in the Stock Market
May 27, 2013

The Past Week: Dow Posts First Weekly Loss Since Mid-April -- S&P 500 Closes Lower For A Third Session Friday!

Stock Market: Concerns By Investors After Fed Stimulus Stops!

Wall Street: The VIX Gains More Than 12% On The Week!

by Ian Harvey

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May 27, 2013

Introduction

The bull market hit a speed bump this past week with the S&P 500 declining for a third day on Friday -- with the three major stock indexes posting their first negative week since mid-April on lingering concern that the central bank may scale back its stimulus measures to support the economy.

Still, the indexes closed well off their lows in light volume for the past week ahead of the three-day Memorial Day holiday weekend. An increase in volatility is often seen prior to a more extended correction. It was a plus that the major averages, especially the stock index futures, closed the past week above the prior week's lows.

Also, the world markets had the widest ranges in the past week that have been experienced in quite a while.

Many of the averages did form daily key reversals on Wednesday, but they have short-term significance when not accompanied by other technical negatives -- a sharply lower weekly close is often the first sign that a top is being formed.

And though many of the US averages closed the week over 1% lower, the recent highs were confirmed by both the weekly and daily technical studies. This suggests that at worst, we are in the early phases of the top-building process.

The market's problems started Wednesday, as the comparison of Ben Bernanke's comments with the FOMC minutes that had just been released spooked investors. The concern that Fed's bond-buying program might end earlier was the reason to sell.

Both indexes had their first weekly losses since the week ending April 19. A disappointing manufacturing report out of China and a sharp fall in Japan’s stock market rattled investors’ nerves this past week. But anxiety over the Federal Reserve’s bond-buying program was the main cause to the downward movement. Some investors interpreted comments from Fed officials to mean that the bank may start pulling its support for the economy sooner than they expected.

The Standard & Poor's 500 Index (SPX), widely used by mutual funds as a proxy for the stock market, lost 1.1 percent for the week. It’s still up 15.7 percent for the year.

This past week's decline caused the S&P 500 to trade below its 14-day moving average, but the index managed to close above the level.

• The Dow Jones Industrial Average (DJI) lost 0.3 percent in the past week to close at 15,303.10.

The Dow still has not had a three-day losing streak this year.

• The Standard & Poor's 500 Index (SPX) dropped 1.1 percent in the past week, to settle at 1649.60

The S&P had its biggest three-day drop in over a month.

On Friday, the S&P 500 had traded below its 14-day moving average - 1,647.91 - during the day but closed just couple of points above the level.

• And the Nasdaq Composite Index (COMP) also dropped 1.1 percent, to finish at 3,459.14.

• The CBOE Market Volatility Index (VIX) ), widely considered the best gauge of fear in the market, ended Friday close to breakeven, down less than 0.1 point, or 0.6%, at 13.99.

The VIX added 12.4% on the week.

It is important to note that Thursday's trading session may have been the most glaring example of just how powerful the bull market in U.S. stocks is right now. Even though all of the major averages closed slightly lower on the day, the U.S. market was able to shrug off a global rout in stock prices that began with a 7.3 percent crash in the Nikkei.


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Investor Concerns in Regard to the Fed

Investors became rattled this past week by signs of a growing split within the Federal Reserve over the size of the central bank's bond buying program, which has been a big driver of the bull market over the past few years. The Fed is on its third round of quantitative easing, but investors seem to be coming to terms with the idea that there may not be a fourth. Market movements are saying the Fed's exit is now more 'when' than 'if'”.

With the market's being extended for quite a while many investors and analysts have been assuming a correction is imminent and maybe it started this past week. However, it is more likely to be a "convenient excuse" for a pullback so that some of the profits can be taken off the table.

Markets have become more cautious since Fed Chairman Ben Bernanke suggested the Fed could start slowing liquidity injections later in the year if the economic data improves enough to warrant it. However, the Fed won't change its position until the economic recovery firmly takes hold.

On Friday, St. Louis Federal Reserve Bank President James Bullard said that low inflation was the "wild card" that needs to be solved, before the Fed can start tapering off its bond purchasing program.

"Before I am in favor of tapering I would like to see some assurance that inflation is going to move back towards target," he said.

Since Wednesday, the markets have been focused on the possibility that the Fed's $85 billion per month in bond purchases will be scaled back later this year, in the wake of recent congressional testimony by Fed Chairman Ben Bernanke and the minutes from the Federal Open Market Committee's latest meeting.

The minutes showed a degree of fracture among the FOMC's members "in terms of the approach moving forward, specifically the time frame" of the unwinding of the Fed's stimulus efforts.

Sideline Monies

The past week provides clear evidence that there is still money on the sideline which is trying to get into equities, (and investors are) looking for almost any excuse to get in – a situation that was apparent all week, with investors taking advantage of down days to put more cash to work, especially when the decline is not based on something fundamental.

Overall, the U.S. stock market's pullbacks have been short and shallow since November as traders have taken any weakness as an opportunity to increase long positions.

Economic Stability

A jump in April orders for long-lasting manufactured goods, such as refrigerators and toasters, showed that the U.S. economy may be stronger than some had thought.

Even as there is some fear that the Fed will exit too soon, many analysts say the eventual tapering of the central bank's stimulus will come with an expansion of the economy and corporate earnings, which will continue to support equities.

Many people had been giving only "the Fed credit for this rally" and had "not been talking about some of the improvement in the labor market or housing data”.

The economy in general has been on a lot better footing than perhaps people have given it credit for.

World Markets

The German Dax closed the week down just over 1%, even though the country's latest reading on business confidence was the best in several months.

The catalyst for the sell-off in Japan centered on concerns about a slowing Chinese economy after a purchasing managers index contracted in May. Despite the steep sell-off in the Nikkei, the country's equity market is still up nearly 40 percent in 2013 after the Bank of Japan launched a massive stimulus program to fight deflation.

In addition to the plunging Nikkei, losses rippled throughout much of the world, with the exception of the United States. The Hang Seng lost 2.54 percent and the major European equity indices were all down a little more than 2 percent on the day.

Asian shares continued to trade erratically Friday of the past week, but European markets found their footing, a day after global stocks were routed by unexpectedly weak Chinese manufacturing and fears the Federal Reserve will start withdrawing its monetary stimulus.

Global Rates

Global rates moved higher in the past week, but interestingly, the increases were the most pronounced in the bonds of the strongest countries, the US and Germany. The uptrends in the yields of the German ten-year Bunds and the US ten-year T-Notes (line a) shows a sharp increase since the start of May.

In contrast, the yields on the Italian ten-year bond have just risen slightly (line b). Rates on Greece's ten-year are still basically in a downtrend (line c), but have fallen from the extremely high yields of a year ago.

Also, a gradual increase in rates is not always a negative for the stock market. It could encourage some bondholders to shift from bonds to stocks.


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Stock Trading Still No. 1

The Performance chart below shows that stocks have continued to be the best investment in 2013, as the Spyder Trust (SPY) is up 15.6%, while bonds as represented by the iShares Barclays 20+ Year Treasury Bond (TLT) are down about 3.4%. Emerging markets, represented by Vanguard FTSE Emerging Markets ETF (VWO), have lost just over 4% so far this year.

Of course, the SPDR Gold Trust (GLD) has been the real casualty, having lost over 17% so far this year. It is now retesting the lows from the middle of April. And silver has been getting even more press as prices have really crashed.

Sector Focus

The iShares Dow Jones Transportation (IYT) stayed above the monthly pivot resistance at $115.90 for several days before it reversed. Despite the drop, the weekly and daily on-balance volume (OBV) are still positive.

Transportation was one of the weaker sectors, as it lost 2.6%. Only the Select Sector SPDR Utilities (XLU) was weaker, closing down close to 4%.

The Select Sector SPDR Health Care (XLV) was the best performer, down "just" 0.1%. The weekly Starc band was exceeded last week. The weekly relative performance also did not confirm the most recent highs, as it peaked in April. The RS line is still above its WMA.

The daily and weekly OBV both confirmed the new highs last week.

As the table below indicates, quite a few of the sector ETFs, like the Select Sector SPDR Consumer Staples (XLP), Select Sector SPDR Consumer Discretionary (XLY), and Select Sector SPDR Energy (XLE), were down about 0.7% for the week. The

Select Sector SPDR Materials (XLB) were considerably weaker as it dropped 1.8% for the week.

Earnings Reports for the Past Week

The Q1 earnings season is effectively over, as only a few reports are still to come. Until this past week, signs of slow but steady economic growth and record profits for big companies had propelled stock-market indexes to all-time highs. Overall, the Q1 earnings season has turned out to be not materially different from what we have been seeing over the last few quarters.

As of Friday, May 24th, we have Q1 results from 489 S&P 500 companies. Total earnings for these companies are up +2.8%, with 65.2% of companies beating earnings expectations. Revenues are down -1%, with only 41.9% of the companies coming ahead of top-line expectations. The median surprise is a respectable +2.8% for earnings and a very weak negative -0.4% for revenues.

The Q1 earnings growth rate and ‘beat ratio’ is comparable to the last few quarters. But the revenue growth rate is lower, with the beat ratio particularly weak in the current period. The composite growth rate for Q1, where we combine the results of the 489 companies that are out with the 11 still to come, is for a rise of +2.4% in total earnings on -1.1% lower revenues.

Weak Retail Reports

A number of retailers dropped sharply following their latest earnings reports. Shares of teen retailers Abercrombie & Fitch and Aeropostale and apparel retailer Gap all declined after their earnings reports.

Sears tumbled after reporting falling same-store sales.

Tech Reports

In tech, Salesforce.com matched Street earnings estimates, but issued a disappointing forecast for the current quarter.

While techs closed slightly lower for the past week there seems to be plenty of opportunities in this sector over the next 12-18 months given the growth in mobile and cloud computing and the eventual recovery of enterprise tech spending.

Crude Oil

Crude oil had a wild week, closing down $2.42 per barrel. It tested the monthly pivot at $92.57 again last week before closing at $93.82. A decisive break of this support would suggest a drop to the $88 to $90 zone, which will add some pressure to the oil stocks.

Precious Metals

The technical action in the SPDR Gold Trust (GLD) was a bit more encouraging last week, as it held above the lows from five weeks ago at $130.51, and actually closed the week higher.

The weekly On-balance volume (OBV) has formed a slight positive divergence, and with the extreme negative sentiment, there may be an opportunity on the long side in the week ahead.

Economic Reports in the Past Week

Over the past two weeks, economic data has generally been quite good. The consumer sentiment data released on March 17 was much stronger than expected, as it jumped to 83.7, up from 76.4 the prior month.

Also in the past week, existing home sales and new home sales were both better than expected. Durable goods were also well above expectations. The data on manufacturing was also encouraging, as the flash PMI Manufacturing Index and the Kansas City Fed Manufacturing Index both reflected steady growth.

Wednesday

Existing Home Sales

Home sales improved slightly in April, rising to 4.97 million from 4.94 million in March. Nevertheless, this came in below consensus expectations calling for an increase to 4.98 million.

Thursday

Jobless Claims

The initial claims level fell to 340,000 for the week ending May 18 compared to an upwardly revised 363,000 for the week ending May 11. This came in better than the consensus expected, with estimates for initial jobless claims pegged at 348,000.

Continuing claims fell from 3.024 million for the week ending May 4 to 2.192 million for the week ending May 11. This compared to consensus expectations calling for a decline to 3.005 million.

New Home Sales

New construction home sales rose 2.3 percent in April to 454,000. This compared to sales of 444,000 in March and came in well ahead of consensus estimates calling for new home sales of 425,000 for April. Prices for new homes also rose sharply last month, recording a year over year gain of 14.9 percent to $271,600.

Friday

Durable Goods

Durable goods orders rose 3.3 percent in April after falling 5.9 percent for March. This came in ahead of the consensus which expected durable goods orders to rise 1.6 percent. Excluding transportation, durable goods orders increased 1.3 percent in April after falling 1.7 percent in March. This compared to consensus estimates calling for an increase in durable goods for April of 0.5 percent.


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Conclusion for the Past Week

Longer-term investors should take advantage of the short-term declines. So far this year, market pullbacks have been shallow as investors take advantage of the declines to add to positions.

The worry about Fed tapering is not really a consideration as there are a lot of other strong underpinnings to support the stock market -- housing, equity inflows and declining stock market correlations which should mean stocks will trade more on fundamentals.


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