How Economic Recovery’s Still Calling the Shots

“Calling the Trend” Column, by George Leong, B. Comm.

Markets are holding, with some indecisive trading at the current levels. On one hand, bulls want to bid stocks higher, but at the same time are concerned about the market’s rise and its sustainability. Markets have declined in four of the last six sessions, but the declines have been marginal and the trading volume has been relatively light. There is clearly not a mass exodus to the sell side, as the sentiment remains bullish. The DOW is holding above 10,400 and the S&P 500 at 1,100. Small-caps also joined in, with the Russell 2000 hovering just below 600.

Investor sentiment remains bullish and we are seeing decent support. We sense that traders want to bid markets higher. The CBOE Volatility Index (VIX) has been declining at multi-month lows, an indication of potentially more gains, as this fear sentiment indicator falls.

Trading continues to be based on the economy and the recovery in 2010. The first-time claims report yesterday was strong, with the weekly claims declining below 500,000 for the first time since January, which added some optimism to the jobs situation. Yet, in the end, we need to see job creation and net gains in jobs before we can feel more confident. The Durable Goods Orders fell 0.6% in October, worse than the 0.5% gain estimated and down from the two-percent gain in September. The data support our contention that, while the economy is improving, there remain issues.

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The final Q3 GDP was weaker than expected at 2.8%, versus the 2.9% estimate; nonetheless, it was still the best showing since November 2007. Home prices also continue to fall. The S&P Case Shiller Home Price Index of 20 major cities showed home prices declining 9.4% in October, worse than the 9.1% estimate, but better than the 11.3% drop in September. Again, the economy is not there yet, but is showing some encouraging signs. Markets could languish given the recent gains.

The Retail Sales report in October was positive. The reading is welcome and indicates that consumers may be starting to spend, which in turn will help drive up the GDP, as the economy rallies out of the recession. With Thanksgiving last Thursday, all eyes will be on the malls and on consumer spending. This is a critical period for retailers and could help to dictate GDP in the first quarter of 2010. The jobs losses along with continued weakness in the housing market will likely continue to make consumers think twice about spending. We feel that consumers may hold back this holiday season and wait for the perceived bargains to follow in January, as retailers deal with potential bloated inventory.

The key Black Friday began last Friday, with the important one-month shopping season widely regarded as the most important shopping period of the year.

Commodities continue to edge higher, as the U.S. dollar index trades at a 15-month low. The Fed said that the decline is orderly. Gold is at another record, above $1,184 an ounce, while oil is holding below $80.00.

Markets may pause and decide whether to continue to trend higher. You should continue to ride the rally, but,again, take some profits along the way.

If markets stall, you may consider writing some covered calls on your long positions to generate some premium income. Be careful, as this strategy is vulnerable to rallies in the stock and loss of potential profits should the stock price move above the strike price where you would be forced to sell the stock.

This week is huge for the economy. Watch for the non-farm payrolls on Friday. Other key economic data expected this week includes Chicago PMI (Monday), ISM Index (Tuesday), ADP Employment Report (Wednesday), Fed Beige Book (Wednesday) and ISM Services (Thursday).