Great Expectations or Just Because?

Daily State of the Markets 
Thursday Morning – January 20, 2011  

The popular press was all over Wednesday’s decline as the U.S. stock market put up its biggest one-day decline in nearly two months. Although I am not entirely sure that you can actually call a drop of -1.01% “big,” Wednesday’s bout of selling did manage to produce the worst batch of red numbers investors have had to deal with since November 23rd. And for those of you keeping score at home, the market-leading Russell 2000 small cap index was tagged for a loss of -2.56% on Wednesday, which might indeed be considered a “big” drop.

Semantics aside, if you have spent any time in this business, you knew this day was coming. After a relentless march higher that began on either December 1st or September 1st (depending on the type of time frame you prefer to use for your market outlook), most anyone who has ever clicked the buy button was probably bracing for some sort of a pullback. After all, trees don’t grow to the sky – even if they have the Fed and a newly inspired public behind them.

Although the major news outlets rambled on about the disappointing bank earnings and the weak housing numbers (is there any other kind of housing number?) being the catalyst for the selling, we’re of the mind that the buyers decided to stand aside yesterday just because it was time, or perhaps because expectations may have gotten a little ahead of themselves.

Don’t get me wrong; it was definitely surprising to see Goldman Sachs miss their revenue target. I mean this is Goldman Sachs we’re talking about here – the firm the made money during the credit crisis by shorting all the bad stuff that was killing everybody else and the same company that has been printing money ever since. But apparently, Goldman, like some of its other Wall Street cohorts, has not been able to make as much money trading now that some of those pesky new rules are being put into place.

While we agree with the idea that it has been the expectations for an improving economy (which is expected to lead to better earnings) that has done most of the heavy lifting in terms the market’s recent run for the roses, we do have to keep in mind that it’s been a good ride. Since September 1st, the S&P had discounted better days ahead to the tune of +19.8% through Tuesday’s close and stocks have gained more than 7.3% since December 1st. Thus, one might argue that some of the expectations for the economy and the market may be getting priced in.

I know what you’re thinking… Isn’t this the same guy who has been yammering on about giving the bulls the benefit of any doubt? Well, yes, that is me. But at the same time, I’ve also been warning that something might come along to put the bears back in business. So, given the fact that Wednesday’s adventure with the dark side didn’t really have a catalyst, we’re keeping our eyes and our minds open with regard to what might come next. Remember, this game is really all about being able to identify the drivers of the action.

So, unless this little pullback turns out to be one of those “just because” affairs, we might want to think about how far stocks can go based on great expectations.

Turning to this morning… Not surprisingly, global markets followed Wall Street lower overnight. Trading overseas is also being affected by the strong GDP report in China, which leads most to believe the tightening cycle is not yet over. This idea is also supported by reports that Chinese banks lent more than 1 trillion Yuan in the first 19 days of January, which far exceeded the allocation for the month (total allocation for the year is expected to be no more than 7.5 trillion Yuan). However, a good number from Weekly Claims has improved the mood a bit here in the U.S.

On the Economic front… The Labor Department reported that initial claims for unemployment insurance for the week ending January 15 fell by 37,000 to 404K. The week’s total was below the consensus for a reading of 423K.

Continuing Claims for unemployment for the week ending January 1 were below consensus at 3.861M vs. expectations for 3.943M and last week’s revised (higher) 3.887M.

Thought for the day: Don’t forget, ego is the real enemy in this game…

Pre-Game Indicators

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

• Major Foreign Markets:
  • Australia: -1.06%
  • Shanghai: -2.89%
  • Hong Kong: -1.70%
  • Japan: -1.13%
  • France: -0.19%
  • Germany: -0.65%
  • London: -1.37%

   

• Crude Oil Futures: – $0.90 to $89.97
• Gold: – $15.00 to $1355.20
• Dollar: lower against the Yen, higher vs Pound and Euro
• 10-Year Bond Yield: Currently trading at 3.396%

   

• Stocks Futures Ahead of Open in U.S. (relative to fair value): 
  • S&P 500: -0.77
  • Dow Jones Industrial Average: -4
  • NASDAQ Composite: -8.12

Wall Street Research Summary

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