DROP IN SECOND QUARTER GDP BOOSTS FINANCIALS -- BOND YIELDS AND DOLLAR DROP-- SOX LEADS TECHNOLOGY BOUNCE
SECOND QUARTER GDP DROPS SHARPLY... Today's report that U.S. second quarter growth fell to 2.5%, which is less than half of the first quarter's +5.6%, carries both good and bad news. The bad news is that the economy is slowing. The good news is that a slowing economy increases the odds that the Fed may stop raising short-term rates sooner rather than later. The markets chose to focus on the good news today. [Futures traders put the chances for an August rate hike as low as 28% after the report]. Not only did the stock market rally. It was led by financial shares which stand to benefit the most if the Fed pauses in August. That's especially true of banks which started to rally last week. The ripple effect in other financial markets was also evident. Chart 1 shows the yield on the 10-year T-note dipping below 5% for the first time in six weeks. Prospects for lower U.S. rates weakened the dollar and boosted foreign currencies. Chart 2 shows the Euro back over its 50-day average and in a short-term rally mode. A stronger Euro (and a weaker dollar) usually boost gold. And they did. Chart 3 shows the GLD having also climbed back above its 50-day line over the last two days (as have indexes of gold stocks). While most stock sectors rose today, rate-sensitive financials rose the most.
Chart 1
Chart 2
Chart 3
BANKS LEAD FINANCIAL SPDR HIGHER ... Today's market is a sort of replay of the events of Wednesday, July 19 when I posted an article entitled: "Bernanke Comments Boost Bonds & Stocks -- Banks Lead Day's Rally" (July 19, 2006). Mr. Bernanke stated that inflation and economic growth were moderating which encouraged the view that the Fed might soon end its rate hikes. The ripple effects of that speech were the same as today's. As the article described, bond prices rose (as bond yields dropped), the dollar fell, and gold bounced. Same as today. And just like then, bank and financial stocks led the day's stock market rally. The earlier article included the next two charts and showed the PHLX Bank Index and the Financials Sector SPDR climbing over their 50-day averages with rising relative strength. [I also showed the Regional Bank Holders (RKH) doing the same]. If the rally in financials is correctly anticipating a Fed pause, that could carry good news for the entire market. That may also explain why other rate-sensitive groups -- like utilities and REITS -- have been rising.
Chart 4
Chart 5
LONGER-RANGE INDICTORS IMPROVE... This time last week, the S&P 500 was still threatening major trendline and moving average support. Its weekly momentum was deteriorating. And it was in danger of giving the first monthly MACD sell signal in three years. As of today, all of those dangers have been reduced somewhat. Let's begin with the weekly bars in Chart 6 which show the S&P bouncing for the second time in a month off a rising support line extending back to the spring of 2005. The weekly MACD histogram remains in negative territory (below the zero line) but has started to rise. [That means that the two MACD lines are still negative, but are starting to converge]. A major buy signal doesn't take place until the zero line crosses back above the zero line. A rising histogram, however, does suggest that downside momentum is diminishing. That's usually enough to justify some short-covering for those on the bear side -- and some "selective" nibbling on the long side. That will be especially true if and when the S&P closes decisively over its early July peak at 1280. Although there's still one more trading day left in the month of July (Monday), it now has a strong chance of ending the month higher. That could be enough to eliminate the "preliminary" sell signal given on its monthly MACD chart earlier in the month (Chart 7). That signal is now in doubt. [So is the sell signal given last week by the 13-34 week EMA moving averages. Both lines rose this week and are now at the same level]. That doesn't mean that the charts have turned bullish. It means that they look less bearish.
Chart 6
Chart 7
OVERSOLD NASDAQ BOUNCES OFF OCTOBER LOW... One of our readers asked me to take a look at technology which has been one of the market's weakest groups. I've stated before that any meaningful stock market rally was doubtful until the tech-dominated Nasdaq market started to rise. There may be some good news there, at least over the short- to intermediate-term. The weekly bars in Chart 8 show the Nasdaq Composite bouncing off chart support at last October's low near 2025. The 9-week RSI line is starting to climb from oversold territory near 30 and has been hinting at a short-term bottom. The weekly MACD lines are improving, but are still in bearish territory. A lot of today's Nasdaq buying is coming from the semiconductors. Chart 9 shows the Semiconductor (SOX) finding some support at its early 2005 lows near 380. The weekly stochastic lines are at the most oversold level in two years. Although the chart is far from bullish, the chips are due for a bounce and that's helping lift the entire technology sector. A tech rally at this point would give a boost to the rest of the market which is already feeding off prospects for lower interest rates.
Chart 8
Chart 9
TELECOM AND DRUGS LEAD PROFUNDS FOR THE WEEK ... My earlier reference to "selective" nibbling on the long side of the market isn't meant to confuse anyone. I've been suggesting for weeks that several defensive sectors have started to rally for the first time in years and were worth taking a look at. Two that I've mentioned this week were pharmaceuticals and telecom. I suggested using Exchange Traded Funds (like PPH and TTH) as a simple way to participate in those upmoves. There are also mutual funds that allow you to do that. Not surprisingly, two of the top sector ProFunds this week were ProFunds Telecommunications and ProFunds Pharmaceutical. Chart 11 shows the telecom fund hitting a new four-year high this week. The real tale in Chart 9 is the rising relative strength line for telecom. It started rising at the start of 2006 (see arrow) and appears to be breaking out to a new four-year high as well. ProFunds Pharmaceutical in Chart 10 is much earlier in a potential new uptrend. It's bouncing off long-term chart support formed four years ago (bottom green line). In addition, the fund appears to have broken a "neckline" in a potential head and shoulders bottom (green circle). [Both funds are plotted through Thursday. Pharmaceuticals and telecom gained more ground today]. Both groups have the advantage of being historically cheap and are just now coming back into favor. That's a good combination for those looking to re-commit some funds to the market or to redeploy money already there.
Chart 10
Chart 11
S&P 500 SPDR IS TESTING ITS JULY HIGH ... I stated a couple of weeks back that the S&P 500 needed to clear its early July peak at 1280 to improve its short- to intermediate-term trends. I stated last week that a close over that price peak would also justify the covering of bear positions. Chart 12 shows the S&P 500 SPDRS (SPY) closing just shy of its July peak at 128.01 (the equivalent of 1280 in the cash index). Upside volume during the week was not impressive which makes me less than enthusiastic about the price gains. A close over the July high doesn't mean that the major bull trend is resuming. It may just mean a retest of the May high. I've already suggested where I'd deploy some new funds if the July high is broken. I'd add bank stocks to that list and maybe even gold. The most urgent decision, however, needs to be made by those holding bear funds. This week's move back over the 50- and 200-day averages warranted some initial short-covering -- especially for short-term traders. A close over the July peak would warrant short-covering for those with an intermediate point of view. Those holding bear funds as a longer-term hedge might want to hold onto some of them until the May high is decisively broken. Although I'm suspicious about the staying power of any summer rally, the first rule in trading is not to fight the tape -- or the Fed. [The Dow Transports, which broke their 200-day average on Wednesday, closed back above that long-term support level on Friday. That prevented a serious weekly breakdown in that key Dow index].
Chart 12
