— by George Leong, B. Comm.
Stock markets are currently trading at a crux, but did make an upward break at key breakout levels (NASDAQ 1,700; DOW 8,400; S&P 500 900-950; Russell 2000 475). Yet, despite the break, stocks continue to trade mixed with a lack of trading direction and could be pressured by a downward revision in U.S. GDP by the Federal Reserve.
The Fed soured the mood of traders last Wednesday after giving a relatively dismal forecast for GDP and unemployment. The news came after the Fed recently said it was optimistic that the U.S. economy would reverse in the second half of 2009. As many of you know, we were hesitant along the way and felt the economy would not turn until 2010.
The Fed said that GDP would contract between 1.3% and 2.0% this year, worse than the previous guidance of 0.5% to 1.3%. For 2010, GDP is predicted to expand between 2.0% and 3.0%, followed by 3.5% to 4.8% growth in 2011. Of course, this is if everything pans out. We find the growth rate for 2010 somewhat high and believe it may be difficult to achieve.
The unemployment rate is also estimated to rise to as high as 9.6% this year and fall to between 9.0% and 9.5% in 2010. Without jobs, consumers will not spend, resulting in less GDP growth.
The numbers are not good and point to an economy that will continue to struggle. The weak forecast will pressure stocks going forward towards the summer months.
Watch for the May non-farm payrolls data — we expect hundreds of thousands of additional jobs lost. This could only get worse, as the U.S. auto sector contracts due to thousands of GM and Chrysler dealerships shut down in a major reorganization plan to save the U.S. auto industry. When these jobs are added, unemployment will swell, especially since there are very little choices for the autoworkers. Moreover, there will also be an impact on auto parts makers and other associated companies. It just seems to get worse.
Traders clearly do not seem that interested in bidding stocks higher and continuing the rally. In addition, new reports of continued weakness in the housing market are driving some of the selling. We believe that there still is above-average market risk and stocks are vulnerable to downside moves.
The fear is that renewed selling could turn into a sustained downward trend and further losses. What is important is that a downward trend does not materialize. The failure to break higher could see the major indices drift in a sideways channel for the summer months, which tend to have lower activity. Markets need to see some leadership.
Caution and volatility remain the key characteristics of the current market climate. The current trading is driven by headlines, which makes volatility a major issue.
As an investor and trader, you need to be careful in this market and protect your capital. Taking big risks could wipe out your capital for trading.