A Fistful of Reasons

Daily State of the Markets 
Thursday Morning – December 16, 2010  

Although the S&P 500 had officially been on a six-day winning streak going into Wednesday, there is no denying that the action has also been getting sloppy of late. And while the bulls have successfully defended their turf against any and all comers over the past week, you just knew that the bears would eventually find a way to get back in the game.

To be sure, a drop of 19 points on the Dow isn’t anything to get uptight about. Even the broader declines seen on the S&P, NASDAQ, and Russell didn’t exactly strike fear in the hearts of the bulls. And to be fair, a pullback of another 15 points on the S&P would be considered normal right about now and wouldn’t inflict much, if any, technical damage. So why am I hearing that this little decline has people feeling more than a little nervous at the moment?

Any card-carrying member of the bear camp likely has a fistful of reasons they can rattle off at the drop of a hat as to why investors should be concerned about being long equities right now. For example, the sovereign debt mess in Europe reared its ugly head again on Wednesday as Moody’s said they might need to drop their rating on Spain by a notch or two in the coming days. Then there is the ongoing concern that China is going to overshoot with their tightening policy and ruin the global recovery.

Frankly, I’m not terribly concerned about either of these issues as I believe it is a bad idea to fight the central bankers of the world and I just don’t see them letting this well-known issue get out of hand. Nor am I overly worried from a big-picture perspective about the current selling in the Euro (which was the primary cause of the stock market’s sudden reversal on Wednesday). As for China, since everyone is talking about this country being the economic superpower of the future, I also don’t see how the powers-that-be are going to fumble the ball on this one.

However, from a near-term perspective I do see how the uncertainty over the EU/ECB/IMF’s next move could cause traders to take a cautious stance. Remember, it is uncertainty that gives markets the most trouble. And speaking of uncertainty, until we get this tax deal put to bed, there is still a little concern that House Democrats might have something up their sleeve. (However, the 82-19 vote in favor of the bill in the Senate Wednesday afternoon should probably be a good indication of how this ought to go in the House.)

Although it isn’t something that makes headlines, one of the nagging concerns I have been having lately has to do with the fact that market sentiment has become more than a little lopsided. Exhibit A here is the fact that the Investor’s Intelligence data showed the most optimism since the bull market began. (If you are interested in this sort of thing, we review a handful of sentiment indicators each day in our Technical Talk report.) The bottom line on the subject is that this batch of “get ready to go the other way” indicators are currently screaming for attention.

However, one of the most important things to understand about any type of sentiment or overbought/sold indicator is that they can stay in an extreme mode for quite some time. As such, it is a very bad idea to base a trading or investment decision on these types of indicators alone. But given that both are waving their yellow warning flags right now, it might be worth recognizing that the bears and their fistful of reasons might have a shot at running with the ball at some point before the end of the year.

Turning to this morning… Stocks are looking to open up a little despite disappointing earnings from FedEx and a bond auction in Spain that once again saw yields rise in dramatic fashion. However, the EU Ministers start a two-day meeting today and thus there is expectations for the group to increase the size of the bailout fund.

On the economic front… The Labor Department reported that initial claims for unemployment insurance for the week ending December 11 fell by 3,000 to 420K. The week’s total was 1K below the Reuters consensus for a reading of 421K. Continuing Claims for unemployment for the week ending December 4 were above consensus at 4.135M vs. expectations for 4.049M and last week’s revised (higher) 4.113M.

In addition, Housing Starts rose by +0.3% in November to an annualized rate of 555K. This was above the consensus for 545K. The October numbers were revised higher to an annualized rate of 534K from 519K. Building Permits for November fell to 530K. This was below the consensus of 537K and last month’s reading of 552K.

Thought for the day: Don’t forget to check the happiness box today…

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell…

• Major Foreign Markets:
  • Australia: +0.32%
  • Shanghai: -0.46%
  • Hong Kong: -1.33%
  • Japan: -0.01%
  • France: -0.24%
  • Germany: -0.11%
  • London: -0.07%

   

• Crude Oil Futures: – $0.41 to $88.21
• Gold: – $8.70 to $1377.50
• Dollar: higher against the Yen, lower vs. Euro and Pound
• 10-Year Bond Yield: Currently trading lower at 3.516%

   

• Stocks Futures Ahead of Open in U.S. (relative to fair value): 
  • S&P 500: +3.17
  • Dow Jones Industrial Average: +30
  • NASDAQ Composite: +4.8

Wall Street Research Summary

Upgrades: