Some random thoughts ahead of key economic data

Well, Mr. Market has a way of humbling its participants and he humbled me this week.  I got sentiment all wrong on Monday, expecting a sell off on what I believed would be a weaker than expected ISM report.  I was right about the report but wrong on the sell off.  Instead stocks shrugged off the worst ISM report since June 2009; a report that is signaling an economic contraction, and moved methodically higher into the holiday.  In its own perverse way, the market took bad economic news as a signal that the FED will have to intervene once more to bolster a flagging US economy.  So bad equals good and "hopium" is still alive and well.

I stated in my commentary last weekend that Friday's rally was overblown and I still believe it.  But to quote John Maynard Keynes, "The market can remain irrational longer than you can remain solvent!"

Here's some random thoughts:

The ECB is announcing their interest rate decision tomorrow.  Most are expecting a 25 basis point cut in their key lending rate.  A few are expecting a deeper cut (50 basis points) and I've read of only one pundit who's expecting they are going to hold steady until August with no change.  I'm in the 25 basis point camp and believe this rate cut is already discounted by the market.  If Draghi cuts rates more than this the market will resume a strong uptrend.  If there is no cut this market will topple over.  If Draghi announces any other easing measures (LTRO, etc.) this will also pump the market higher.

I'm ambivalent on the weekly jobless claims coming out at 8:30 AM EST and also on Friday's monthly employment report.  The weekly series is volatile and tomorrow's report may be overshadowed by Friday's bigger report.  All I can say here is that we've had some disappointing reports over the past few months and just on that basis odds favor better than expected reports.  However, the global economy is clearly slowing and the word around the street that it somehow is not going to effect us is nonsense.  The ISM report already disproves that thesis and  we're already seeing earnings reports from multi nationals like Nike that have been negatively impacted by the deepening recession/depression in Europe.

There's been much commentary regarding how Angela Merkel caved into Monte, Rajoy and Hollande last week but when you really dig into what came out of the EU Summit very little has changed.  Yes, banks can now directly access money from the EFSF/ESM but Germany (and other EU states) still have to vote on whether to release the funds.  Already the Finns and the Dutch have already publicly announced they will not allow this kind of lending.  And secondly, conditionality will still apply.  There will be no free lunch for periphery banks or their sovereigns.

The only thing that came out of the summit that was ground breaking was the effort to appoint a central banking authority but the lack of detail surrounding this announcement almost guarantees that the appointment of an entity (possibly the ECB) to head up this authority by the year end deadline will not be met.  And banks can't directly access the EFSF/ESM money until this authority is in place!

So, in retrospect, why did the market rally?  Because expectations were so low going into the summit that the least indication that there was fractional cooperation between the parties at the summit was enough to ignite this rally.

(click on chart for larger image)

Here's a daily chart of the Russell 2000 and I've circled the price action since last Friday.  First and foremost, regardless of any opinions I might have that this market is overreacting to the news out of Europe it is dangerous to disregard this kind of price action.  This is a small cap index and it is showing relative short term strength to it's larger brother, the S&P 500.  It is moving into a significant resistance zone and the trading channel set earlier in the year between the 61.8 and 100% Fibonacci levels but unless we see a turn around soon then I have to concede that my thesis is wrong.

The chart above is a daily line chart of the NYSE Composite Index which covers all the common stock listed on the New York Stock Exchange.  In the lower panel is an indicator developed by Marty Zweig called the Zweig Thrust Indicator.  I've pointed to where we are at with the purple arrow.  The New York Composite is at resistance at the 7900 level but the indicator is signaling significant upside momentum.  Interestingly however the fact that it has breached the horizontal red line is also a possible signal that this incredible short term rally is living on borrowed time.

Are stocks signaling that all the bad economic data we've been getting are wrong?  Are stocks forecasting that we are already climbing out of an economic "soft patch"?  I'm skeptical especially since China is still contracting and its stock market is going nowhere!

That's where we're at.  We'll know about the ECB interest rate decision by 7:45AM EST tomorrow and from there the fireworks start with the employment report at 8:30AM EST.  We will also wake up to the results of several Spanish bond auctions that will take place between 4 & 5 AM EST.  Spanish yields are already edging higher again.

Have a great 4th!