Business and Financial Guido's Weekly Market Notes: Catalyst for Next Leg Higher Could be a Rate Increase

Posted Friday, August 28, 2015 12:00 am

Bruce A. Bittles

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The popular averages hit a new intraday high early last week. The broad market, however, produced the near opposite results with more stocks going down than up and more issues hitting new 52-week lows than those reaching new highs. As a result, the Dow Industrials show a small loss for the year while the S&P 500 Index is up just 1.00%. Small-cap stocks were among the weakest performers falling nearly 3.00% last week.

The unusually large number of diverging trends is a mirror image of the top and bottom line results found in the latest earnings reports. Second quarter earnings produced a few bullish surprises the past two weeks but misses are widespread in many issues that are sensitive to the business cycle. This is occurring at a time when valuations are stretched leaving little room for disappointment. This suggests a continuation of the trading range environment in effect the past four months with the risk to 2044 and the reward to 2130 using the S&P 500.

The Federal Reserve meeting concludes on Wednesday, which could add to the level of uncertainty in the market. Consensus opinion is that the Fed will raise the fed funds level 25 basis points in September or December. Yellen’s decision will not be easy given that the U.S. labor markets are moving toward full employment at the same time that world commodity markets are plunging. The CRB Raw Industrials Spot Price Index is at its lowest level since 2009. The Bloomberg Commodities Index is at levels not seen since the recession year 2002. The other end of the bar bell shows U.S. jobless claims at the lowest level since 1973. The four-week average of claims fell to the lowest level since the second quarter of 2000.

Second quarter GDP will be reported on Thursday. Economists generally believe the U.S. economy grew 2.8% for the period. A stronger number would likely be interpreted as a vote for a rate increase sooner than later. No decision is due at this week’s meeting but the uncertainty over monetary policy could weigh on the financial markets.

The technical condition of the stock market is precarious following last week’s performance that produced a number of diverging trends. Although market breadth has been problematic since early in the year, last week’s performance is close to turning the Tape negative. We are concerned by the fact that only 61% of the industry groups within the S&P 500 are now in defined uptrends, which is a new low for the cycle. Our level of concern would elevate should the industry participation rate fall below 60% and the S&P 500 and Dow Industrials close below their July lows of 17465 and 2044 by the S&P 500 Index.

The good news is that entering the new week stocks are trading at support and sentiment indicators show no evidence of excessive optimism. This opens the door for a potential rally back toward the 2100 level on the S&P 500.