How Will the Market Respond to Our Government's Theatrics?

Includes: DIA, QQQ, SPY
by: David Brown

Despite spending much of the day below the 200-day moving average, the S&P 500 closed at 2986.94, just barely above the 200-day MA, thus, avoiding a marker that hasn’t occurred since last September.

Clearly, the market is going to track the outcome of the amateur theatrics that we’ve seen in Congress over the past several weeks. The market will stabilize and rise when the Senate passes the debt ceiling bill, which passed the House Monday afternoon — or the market may free-fall if the bill fails to pass. How far and how fast the market rises or falls depends on the actual measures contained in the bill and, more importantly, the ramifications of those measures.

There’s no doubt that Congress’s amateur performance over the past ten days has inflicted significant damage to the market, the economy, our global respect, and the confidence and morale of the public. Last week’s report on second quarter GDP revealed an economy growing more slowly than expected — +1.3% versus the expected +1.9%. But the real shocker was the revision of the first quarter GDP number. Instead of growing 1.7% as reported last month, the revised number showed a scant 0.4% growth.

Last week’s durable goods report revealed a huge drop from May’s +1.9% to June’s -2.1%, which was considerably lower than the expected +0.5%. Today’s ISM Manufacturing Index reading put a big fat exclamation point behind the slow-growth indicators, coming in barely expansive, at 50.9. Anything less than 50 means the economy is contracting.

The bottom line is we have a barely growing economy, with very high unemployment. And the clowns in Congress want to reduce government spending?

I know of no economist who thinks that any good result can come from that. As David Frum, a CNN contributor and avowed Republican, summed up in his column today: “Wake up GOP: Smashing system doesn’t fix it.

But hey, the show must go on.

Market stats. Our market stats accurately reflect the mood of the market, with the most negative weekly numbers this year. The best performing award goes to Large-cap Growth, which lost nearly -4.0% for the week, while Small-cap Growth captured the loser’s trophy with a -5.8% loss.

No sector even came close to positive. Public Utilities, the ultimate flight-to-safety haven, took top honors, with a -1.5% loss; Consumer Non-durables, the penultimate safe haven, was next, down -2.6%. The biggest losers among the sectors were Capital Goods, down -5.8%; Consumer Durables, down -4.7%; and Transportation, down, -4.5%.

Some tiny glimmers of light showed up in all this gloom. Initial jobless claims sneaked below 400K last week, just barely, to 398K. Consumer confidence actually rose a couple of points to 59.5, but that reading was taken last Monday when we had a whole week to solve the debt ceiling crisis. I’d like to see the reading now, as we totter on the edge of the precipice. Another way of looking at consumer confidence is the University of Michigan’s consumer sentiment report, released on Friday, which showed the July reading as the weakest since Q1 2009.

The brightest light comes from corporate America in this Q2 earnings season. Sixty-eight percent of ALL reporting companies beat earnings estimates. (Seventy percent of the S&P 500 companies have reported thus far.)

So it seems the world as we know it isn’t going to end just yet—assuming the debt ceiling plan, as flawed as it may be, actually passes the Senate in the next 24 hours.

Looking forward. Our forward-looking SectorCast forecast favors Energy, Finance, and Basic Industries, and is least favorable to Transportation, Consumer Services, and, surprisingly, Consumer Non-durables.

Here’s another way to look at sectors when considering stocks or ETFs for investments. Bespoke Investment Group offers an interesting forward look at sectors by ranking them according to the positive vs. negative guidance given by the underlying public companies in their quarterly earnings releases. The most positive guidance this quarter came, surprisingly, from industrials, which shows that 13.8% of the companies in that sector gave positive rather than negative guidance, compared with a historical average of 8.9% (a +4.9% difference). Consumer Non-durables was next, with +2.4% difference, and Consumer Durables was the only other sector with a positive difference (+0.8%).

Sectors with more negative than positive guidance were Technology (-5.4% difference), a surprise, since this sector normally leads in positive guidance; Health Care, -3.3%; and Energy, -1.6%.

It’s clearly a time for investor caution, especially until the final outcome of the debt ceiling bill is understood, along with its ramifications. The most important of which is whether we retain our Triple A credit rating and whether anyone will devise a plan to reinvigorate our economy.

Upcoming Economic Reports

Tuesday, 8/1 Personal Income & Spending
Wednesday, 8/3 ADP Employment ReportFactory Orders

ISM Non-manufacturing Index

Thursday, 8/4 Weekly Jobless Claims
Friday, 8/5 Employment Situation Report
Monday, August 8 Nothing of Interest

Stock ideas are below the tables.

4 Stock Ideas for this Market

This week, I started with the GARP (Growth At a Reasonable Price) preset search in MyStockFinder. I also included Buys (in addition to Strong Buys), and slightly upweighted Technicals. Here are four stock ideas that look particularly intriguing for this challenging market:

Tesoro Corp (NYSE:TSO) – Energy
Signature Bank New York (NASDAQ:SBNY) – Finance
The Mosaic Company (NYSE:MOS) – Basic Industries
Coca-Cola FEMSA (NYSE:KOF) – Consumer Non-Durables