Reliance Investment Management

It was a volatile five days  for the USA stock markets over the past week.  On Monday & Tuesday, the S&P 500 fell by 3.5% as the investment community worried  that the USA economy was contracting at a faster rate than previously expected.  However, the Central Bankers of the world came to the rescue.  On Wednesday, a Wall Street Journal story reported that the USA Federal Reserve was ready to act if the economic conditions deteriorated much further.  Next on Thursday, the European Central Bank (ECB) Chief stated that the ECB would do “whatever is necessary” to protect the Euro.  Finally on Friday, the presidents of France & Germany announced in a joint statement  that they would do whatever they could to protect the European region from an economic downturn.

All of this commentary from the central bankers and European Political leaders gave a nice lift to stock markets worldwide.  The S&P 500 rose 4.5% from it’s lows of the week to finish the week ending July 27, 2012 at 1,386

(Click on Image of Chart for a Bigger Picture)

We would like to remind our readers that this action in the market is a pattern that continues to repeat itself over the past 2 months.  Looking at the chart above, the markets have rallied at each of the 4 low points from government and central bankers commentary that has resulted in giving the markets a short term lift higher on each occasion.   It happened again this week.  The question is will these most recent gains in the markets hold?  Or will the markets sell off again once the euphoria of the most recent commentary passes?

Now technically speaking, the USA markets are in a nice upturn pattern.  If we felt better about the USA (and world) economy now we would be much more bullish on equities here.  However regardless of the economy,  the S&P 500 has put in a series of Higher Lows & Higher Highs,and this is usually bullish for stocks.  We have prepared a four month chart for you of the S&P 500 that illustrates this below:

(Click on Image of Chart for a Bigger Picture)

It was an active week on the Economic Front – Below are the highlights:

Initial Unemployment Claims came in at 353,000  – Better than expected.

GDP reported at 1.5%  -Better than expected but still very weak on a historical basis.

Consumer Confidence reported at 72.3  – Better than expected  – but still at 8 month lows.

New Home Sales came in at 350,000 – Worse than expected.

We have reported in earlier commentaries that we believed that in general the USA housing market had bottomed  in both pricing and in new construction.  While the housing market has turned up over the past few months and for the first time in years is actually adding economic benefits to the overall economy, the levels that housing is starting from are still very depressed.

Below is a 50 year chart of New Home Sales.  Note how low the recently reported 350,000 New Homes Sales are compared with sales over the past 50 years.   Also note  \how low the  New Home sales for the years 2011 & 2012 when you compare these two years with the other 48 years.

(Click on Image of Chart for a Bigger Picture)

The good news as you can see from the chart is that after the largest decline in history,  New Home Sales have turned higher.   So while the economy will benefit from an improving housing market, the levels that the improvement is starting from are so low that the short term economic impact will not be as great as what some recent optimistic headlines have indicated.

Forecast for the Next Week

As noted in the chart above, the S&P 500 has put in a series of recent higher lows and higher highs – technically this is short term bullish for equity prices.  However, we think eventually the markets will recognize the failing health of the US economy and will price this in.  Additionally, the last four recent moves higher in the markets have all come form public commentary from central bankers and government officials and not because of improving corporate earnings and improving economies.

We are currently in the midst of earnings season and while many companies are meeting expectations on the bottom line (profits) only 48% are beating their sales guidance.  The 48% of companies beating their revenue guidance is the lowest since 2008.  Additionally, the spread between the numbers of companies who have raised forward guidance versus the number of companies who have lower forward guidance is also at it’s lowest rate since  2008.

With the S&P within 3% of it’s post 2008 highs, and with the rest of the world and USA economies weakening, we continue to recommend that investors use this strength to strategically raise cash in their portfolios.