The uncertainty in Europe continues to dominate global market action, and it remains unclear whether Europe as a whole will move fiscally closer together or monetarily further apart in its efforts to solve its problems. The combination of fiscal rescue packages and increased austerity measures seems to be the clearest path to success, but investors are rightfully questioning whether, for example, Greece will be able to become austere enough for the markets to regain confidence. Within the United States, the economy continues to show slow signs of improvement. First-quarter gross domestic product (GDP) growth was revised slightly lower (from 3.2% to 3.0%), but consumer confidence readings rose in May as the improving labor market overshadowed stock market volatility. On the earnings front, both reported results and expectations have risen over the past couple of months as well.
The main issue currently plaguing investors is the degree to which fundamental uncertainty has inflicted damage on overall economic conditions.
The most pessimistic view is that we are witnessing the beginning of a movement that will drag down the global economy; the most optimistic outlook is that what we are seeing is no more than mindless panic, which will be quickly overcome by fundamental strength. We are not subscribing to either extreme, but our sympathies lie more with the latter than with the former.
By our analysis, investors are beginning to move from panic mode to a wait-and-see approach, and while we do think that fundamental strength will win out, we acknowledge that it will take some time.
U.S. NUMBERS STILL LOOK GOOD, from Michelle Knight, manager of fixed income, Silver Bridge Advisors
This past week's U.S. economic data signaled that the financial turmoil has not yet had a discernable effect on demand growth. Consumers so far have disregarded the European crisis and declines in U.S. equities, and businesses are on track for another strong gain in equipment investment in the second quarter. Indeed, the Conference Board's consumer confidence index soared from 57.7 in April to 63.3 in May, its highest level since March 2008 as Americans become more upbeat about job prospects. The University of Michigan's consumer confidence index likewise inched higher, from 73.3 to 73.6 for the month. Meanwhile, durable goods orders jumped +2.9% in April and were revised from a decline of -1.3% to unchanged in March. April's headline gains in durable goods were driven by a stunning +228% increase in civilian aircraft orders in the month after a -71.2% drop in March. While orders ex-transportation fell -1.0% in April, they were revised higher from +2.8% to +4.8% in March, and all component categories still show solid year-over-year growth. However, in less encouraging news, regional manufacturing data showed some slippage in May, with the Chicago Purchasing Managers' Index falling from 63.8 to 59.7, and the Richmond Fed manufacturing index sliding from 30 to 26.
Though less influential in its second release, GDP for the first quarter of 2010 was revised downward from +3.2% to +3.0%, reflecting smaller gains in consumer and business spending as well as exports, perhaps highlighting the risks to recovery posed by the European debt crisis. The April outlays report revealed that while personal income equaled economists' expectations, rising +0.4% month-over-month, personal spending was flat. At least for the month, instead of spending, consumers chose to save, with the savings rate climbing by +0.5% to 3.6%. The PCE deflator increased by a manageable +2.0% year-over-year, and the core PCE deflator, the Fed's preferred inflation gauge, rose +0.1% for the month and +1.2% year-over-year, keeping the inflation rate well within the Fed's comfort zone and close to the lowest level since 1963.
In housing news, new home sales jumped +14.8% to 504,000 annualized in April as buyers rushed to take advantage of the homebuyer tax credit before it expired. While the pop in sales is welcome, the MBA's mortgage purchase index tumbled to an 11-year low in May, suggesting sales will fall back. The S&P Case-Shiller home price index of property values in twenty cities increased +2.4% from March 2009, though prices fell -3.2% from the fourth quarter 2009 to the first quarter 2010. Federal tax credits have clearly succeeded in propping up home sales and creating the conditions for stabilizing market prices, raising concerns that the looming end of government support will spell another round of losses. Meanwhile, weekly initial jobless claims remained stubbornly high at 460,000 last week, and belie the strength expected to be reported Friday in the May employment survey. Continuing jobless claims were almost unchanged at 4.6 million.
BEARISH TIMES, From Charles Biderman, CEO, TrimTabs
We are more bearish than we would be otherwise because of the sovereign debt crisis. Debt levels in many developed countries are approaching or exceed 100% of GDP, and no big technological breakthroughs are on the horizon to boost economic growth. As a result, we think recent downgrades of the debt of Greece, Portugal, and Spain are just a harbinger of a massive re-rating of sovereign risk that lies ahead. We do not see any resolution to the crisis that does not involve sovereign defaults or money printing. Either choice will result in lower asset prices and higher market volatility.
Fears about sovereign solvency seem to have sharply reduced market participants’ appetite for credit risk. Not only have interbank lending rates and corporate bond spreads moved higher, but investors are pumping a lot less money into bonds. The estimated inflow of $8.8 billion (0.4% of assets) into bond funds in May was the lowest since December 2008. If investors are unwilling to play the speculative game central bankers are encouraging, the economic recovery could get snuffed out quickly.
Recent market volatility has spooked retail investors. The American Association of Individual Investors reports that 50.9% of respondents to its latest sentiment survey were bearish, the highest percentage since November 2009. Also, outflows from equity funds have been extremely strong. In May, U.S. equity funds lost an estimated $30.3 billion (0.7% of assets), the fifth-highest monthly outflow in history. Historically huge outflows have been a useful contrary indicator.
But retail investors have not been driving stock prices since the March 2009 low, so we are skeptical that their selling is the sign of a bottom. The key drivers of the rally have been hedge funds and trading desks, the latter of which can borrow from the Federal Reserve at basically no cost. Speculative players still seem eager to bottom fish. In the past two weeks,
leveraged long ETFs issued a whopping $1.3 billion (16.3% of assets). Equity ETF flows are one of the best contrary indicators in our flow data, and we would be a lot more confident stock prices were bottoming if leveraged long ETFs were posting outflows, not inflows.
SAILING WITH THE WIND, from Jeffrey Saut, chief market strategist, Raymond James
In the markets investors need to be adaptable and have the ability to adjust to the environment. You must be flexible; or, as the old sailor’s axiom states – you can’t change the direction of the wind, but you can adjust the sails. And clearly the stock market’s “winds” have been in a downdraft with the month of May going into the record books as the worst May for the S&P 500 (SPX/1089.41) since 1962. Granted, the May Melt could have been worse if the SPX had stayed at last Tuesday’s low of 1040.78, but as stated in that morning’s strategy comments – most of my oversold indicators are about as compressed as they ever get. My friends at the invaluable Bespoke Investment Group put it this way, “The S&P 500 and all ten sectors are in extremely oversold territory. We recommend getting long here regardless of your long-term view of the market.” Subsequently, the SPX experienced a ~6% rally that took it back to its still upward sloping 200-day moving average (DMA). Most technical analysts would note the 200-DMA is a natural place to expect some sort of consolidation and/or pullback, and that’s exactly what we got last Friday.
This week, however, the markets will have to deal with another disappointment as BP’s (BP/$42.95/Market Perform) top-kill operation failed to stop the tragedy in the Gulf. While horrific, I continue to think this tragedy assures the viability of Alberta’s Athabasca oil sands deposit. Canada is a stable country and the oil sands require no drilling. Indeed, the Athabasca deposit is 54,000 square miles of oil-soaked earth believed to contain roughly 1.7 trillion barrels of oil. Even without the Gulf catastrophe, the oil-sand metrics were improving with higher oil prices, lower natural gas prices, and low light-to-heavy crude oil differentials all contributing to a more constructive environment. While our Canadian-based energy analyst follows numerous oil sands companies, my favorite in his coverage list continues to be 3%-yielding Cenovus. Cenovus should
provide more information on its development plans at this month’s Investor Day on June 17th. As well, I continue to like North American Energy Partners, which is also followed by our Canadian analysts with a Strong Buy rating.
STILL BULLISH ON GOLD, from David Rosenberg, chief economist and stratetegist, Gluskin Sheff
There is no doubt that, when benchmarked against the CPI, money supply and GDP, gold can easily double from here. Demand is always difficult to forecast, especially for jewelry, but we do know that central banks have very deep pockets and bought more gold last year (425 tons) than at any other time since 1964.
The supply backdrop is also highly conducive to a sustained bull market. Mined production is no higher now than it was a decade ago and has fallen outright in 5 of the past 8 years. And, we know what the marginal cost curve is doing because there is so little cheap supply left in the ground that gold companies now have to drill as much as 2.3 miles to get to the yellow metal in South Africa (and all Bernanke has to do is press a button).
REPORTS CALENDAR
Tuesday, June 1:
May ISM Manufacturing Index; April Construction Spending
Wednesday, June 2:
May Motor Vehicle sales; May Challenger Job-cut Report; April Pending Home Sales; Mortgage Applications (weekly); Same-store Sales (weekly)
Thursday, June 3:
May Chain Store Sales; May ADP Employment Report; May ISM Non-Manufacturing Index; April Factory Orders; Jobless Claims (weekly); First Quarter Productivity and Costs;
Friday, June 4:
May Nonfarm Payrolls and Unemployment
