Friday's Losses Not as Bad as They Appear: Favorable Outlook Ahead

 |  Includes: DBA, IEZ, SMH, SPY, VTI, XES, XLE, XOP
by: Chris Ciovacco

On the heels of the negative reaction to Friday’s employment report, it is a good time to review both the market’s outlook (NYSEARCA:SPY) for the next few months and our possible investment approach. For those keeping score at home, the consensus forecast for Friday’s employment number was 180,000; the range of forecasts spanned from 120,000 to 255,000. The actual number came in at 195,000.

Although Friday's market was decidedly weak, Thursday saw the biggest gain in stocks thus far in 2011. According to Bloomberg:

The Institute for Supply Management’s index of non- manufacturing businesses increased to 59.7 from 59.4 in January. The median forecast of economists projected the index would fall to 59.3. Same-store sales rose 4.3 percent last month, beating an overall compilation of analysts’ estimates for a gain of 3.8 percent at the 27 chains tracked by Retail Metrics. Separate government data showed productivity climbed more than estimated and labor costs dropped more than forecast.

If we compare market internals from Friday's session to Thursday's stats, Friday's losses do not look as bad as they appear at face value. Market breadth was decidedly positive Thursday, especially the up/down volume stats for the NASDAQ. Thursday's trading volume was slightly higher than the previous session on both the NASDAQ and S&P 500, but a little disappointing relative to the magnitude of the gains. Friday saw the S&P 500 drop 0.74%, but trading volume was lighter than Thursday's session, indicating the desire to sell may be tailing off somewhat. Another positive from Friday's trading day was the S&P 500 fought back near the close to move from the intraday low of 1,312 to close at 1,321.

This week we have updated our asset allocation models, which allows us to compare 220 asset classes/sectors/investments head-to-head. We have a short list of possible buy candidates should it be needed on Friday. The recent strength in economic data still has energy (NYSEARCA:XLE) and numerous energy-related subsectors looking attractive, including oil & gas equipment and services (NYSEARCA:XES), oil & gas exploration and production (NYSEARCA:XOP), and oil equipment providers (NYSEARCA:IEZ).

An economy that may not have been hurt as bad as anticipated by rising oil prices also puts the broad market (NYSEARCA:VTI) and economically-sensitive semiconductor manufacturers (NYSEARCA:SMH) on our short-list of possible buy candidates. Agriculture (NYSEARCA:DBA) has been consolidating for a month and may be poised to regain traction should the market applaud the much-anticipated employment report due Friday morning at 8:30 a.m. ET.

Robert W. Baird upgraded Intel Corp (INTC), Altera Corp (ALTR) and some other semiconductor stocks and said it expects PC and wireless infrastructure trends to rebound in the second half of 2011. The brokerage said its recent field research points to a continued rebound in order trends for semiconductors, resilient lead times, lean inventories, and a favorable pricing environment, which should lead gross margins to continue tracking at above-historical levels.

Semiconductors Relative Strength

Could the pike in oil help investments in agriculture (DBA)? The United Nations Food and Agriculture Organization (FAO) Thursday said the global food prices keep rising and prices of all food commodities except sugar rose for the eighth consecutive month in February. The Rome-based agency warned that the unexpected spikes in oil prices could exacerbate an already worsened situation in food markets.

We would prefer to see market participant's tolerance for risk on Monday before making any moves. While Thursday’s market was impressive and Friday's losses not as bad as they could have been, numerous short-term indicators, including MACD, have not crossed bullish thresholds, meaning we will remain patient with cash until we see what we want to see. For those who want more technical analysis, this post shows additional things we are looking for in terms of feeling better about the recent rally attempt.

Like to See

In terms of the market’s outlook for the coming months, the CCM 80-20 Correction Index tells us the market’s current profile has produced favorable results more often than not over a three-to-twelve month time horizon. As we mentioned on March 3, we are still concerned about corrective activity, but we are not concerned about a full-blown bear market at the present time.

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Risk Reward Profile Stock MarketClick to enlarge

Similarly, the CCM Bull Market Sustainability Index (BMSI) also points to a favorable risk-reward profile for investors looking out three-to-twelve months.

Stock Market OutlookClick to enlarge

As shown below, the S&P 500 still sits above potential support from 2008. The recent intraday low was 1,294, which was made last Thursday. As long as we hold above 1,294ish to 1,291ish, it makes sense to hold our current positions. We closed Friday at 1,321.

Stock Market SupportClick to enlarge

The market should continue to get support from the Fed. Earlier this week Dennis Lockhart, Federal Reserve Bank of Atlanta President, said it would be “wise” to complete the Fed’s planned $600 billion of asset purchases as scheduled under the program aimed at boosting U.S. growth.

Disclosure: I am long XLE, IEZ, VTI. Generally, I am long global stocks and commodities.