What an awful week for the markets!! The S&P 500 closed the week at 1292, down 3.9%. It was the worst week for the markets in over a year. The Dow Industrials Average was off 4.2% while the NASDAQ did slightly better with a 3.6% drop. At 1292 the S&P 500 is holding just slightly above its 200 day moving average. The S&P has not closed below this level in over a year. The 200 day moving average is the last major moving average support that we follow. Generally there should be an attempt by the bulls to defend this area of support. A break of this level would leave the bulls to defend the recent lows around 1260, after that it is anyone’s guess.
With the S&P 500 closing down 5 straight days and getting oversold, any good news could rally the market sharply. The problem is that the market is not only discounting the debt debate, it is also discounting the continued problems out of Europe. We see this potential rally in equity prices as a likely time to reduce exposure to the market. The debt debate will likely get resolved with a debt ceiling raise, but as we wrote (http://momentrixreport.com/?p=1008) it’s the downgrade stupid!! None of the plans that are being floated as of yet approach the level of spending cuts that both S&P and Moody’s have outlined to avoid downgrade, $4 trillion over ten years. Mark Zandi, the Chief Economist of Moody’s, is on the wires saying the current framework of a deal on Sunday would be enough to delay a downgrade, but we remain skeptical at this point. We would like Washington to take these bad omens very seriously and take a significant step to solvency. Remember that an announcement of a deal and the passing of the deals in Congress are two different things and a failure to pass would make any rallies short lived.
The week ahead will be focused on the Debt ceiling votes as Washington tries to get its act together. Although the news and eventual passing of the Debt ceiling raise and corresponding budget cuts is a positive and should engender a positive market reaction, the form the final bill takes will be the key to the reaction of the ratings agencies. Should the final bill come up short of the expected spending cuts, the agencies could act anyway, creating unknown effects in the markets.
Europe continues to be a problem and could be the real reason for the continued weakness in the markets last week. CDS spreads and Interest rates in Europe continued to move higher last week, particularly in Spain, Italy, and Portugal. Equity markets around the world continue to be weak, potentially discounting slowing growth in the world economy. Australia, India and Brazil are down significantly this year and are views as growth drivers for world. We would like to see these markets turn around along with other markets. We continue to watch Europe along with world equity markets for signs that the worst has been discounted. This is not the case as of yet.
The earnings calendar will continue to be full this week. This is the last peak week of earnings results and then going forward the pace of results will slow for the duration of the quarter. Results continue to be impressive but guidance is mixed at this point. In some cases we feel it is companies trying to manage expectations, something that Apple Inc is extremely good at, eventually allowing easier earnings beats. The guidance should not be ignored though, as the economic statistics are showing definitive signs of slowing along with the difficult operating environment of lackluster macro demand and surging costs.
The economic calendar (http://www.nasdaq.com/markets/us-economic-calendar.aspx) will be full this coming week. The highlight of the week will be the employment report on Friday. The report will very likely continue to languish as the initial claims have been well above 400,000 with the exception of last week. The pace of job creation is not large enough to put any significant dent in the number of unemployed. With economic statistics showing early signs of slowing, there is no reason to think the pace of hiring has increased in the past month, especially with all the uncertainty that business faces right now. One interesting event on Thursday will be the European Central Bank and the Bank of England announcing their interest rate policies. Markets could react to this decision considering the magnitude of problems that Europe faces.
We remain defensive going into the week. We added a slight hedge on Friday (yes we were late) along with the significant cash position as the likelihood of a debt downgrade increased last week. As we witnessed in the TARP debate, any failure to pass an agreed upon bill may cause a sharp sell-off in the market. A debt downgrade could have detrimental effects as almost every interest rate in the world is some way related to the US treasury and its AAA rating. We hope the defensive position is unwarranted; if it is the right move it will not be a good time for the equity markets.