3 Reasons The Market Will Likely Continue To Decline This Week

Includes: AAPL, C, CAT, GE, SPY, XOM
by: The Independent Investor

Wow, the market isn't going straight up any more. While the S&P 500 and its tracking exchanged traded fund, SPY, have rallied over 15% since the market's lows of last year, and stocks such as Apple (NASDAQ:AAPL) are up over 30% in the last year, the last two months have been brutal.

While the S&P 500 has sold-off around 8% in the last month, cyclical sectors such as energy, the industrials, and the financials, have underperformed most of the broader indexes by a fairly wide margin over the last several months. Market leaders in may cyclical sectors, such as GE, Caterpillar (NYSE:CAT), Citigroup (NYSE:C), and Exxon-Mobil (NYSE:XOM), have been weak of recent as well.

The first reason I think the market will decline next week is that significant near-term intervention by Central Bankers and Government leaders is unlikely. The market rallied for nearly two weeks after the Spanish bailout, on the prospect of increasing intervention by the European Central Bank, and the Fed. Still, the Fed continues to reiterate that major new quantitative easing programs are unlikely in the near-term. With the presidential election season kicking of, and Congress usually taking an early July recess, significant new fiscal initiatives remain unlikely as well.

While the Spanish bailout will likely be the first of many future bailouts and of the PIIGS and these countries' banks, the European Financial Stability Facility was originally funded with only around $250 billion dollars, and even though the fund was recently increased to over $400 billion dollars, the European Central Bank has limited funds and flexibility to use such funds for similar bailouts in the future.

With Spanish regulator suggesting that Spain will likely need at least $50-60 billion more to recapitalize the country's financial system, and Italian banks likely need significant new capital as well, intermediate and long-term yields on the PIIGS bonds will likely remain high. While Germany has called for an increase in the EFSF to over 2 trillion, the country continues to resist the idea of refocusing the EFSF on actual bond purchases, and German opposition parties continue to oppose he idea of a Euro bonds. Italian and Spanish yields remains high, and the EU's new fund, the European Stability Mechanism, which has been setup to recapitalize banks, is only set to be funded with $22 billion, and has yet to be approved by many European parliaments.

The second reason the market will likely decline next week is because the growth outlook continues to deteriorate at an increasingly alarming rate. While many leading economic indicators, such as jobs and manufacturing reports, have been weak for some time, the recent Philly Fed report of negative 16.6, was significantly below the already lowered expectations of a 0 reading.

Recent economic reports in Europe have also been well below expectations. In Germany, while the closely watched IFO index measuring business confidence in the Euro-Zone's biggest economy, fell only slightly, the highly respected ZEW survey, which measures business confidence in the Euro-Zone's largest economy, showed its sharpest drop in nearly 14 years. Recent surveys with purchasing managers in Germany also suggest that the country's manufacturing sector will likely continue to contract.

Finally, the last reason I think the market will likely continue to decline is because of continued pressure on major commodities, such as copper and oil. While oil prices appeared to be stabilizing at around $80 a barrel, and copper prices stabilized for a couple weeks at around $3.50 a pound, oil has now broken the $80 dollar level, and Copper has sold-off below $3.30 a pound. Oil prices topped out around $100 a barrel in early March, and the world's most traded commodity has been very weak for last several months as weakening demand in China, a strong dollar, and Iran's increasing willingness to cooperate with international authorities, have weighed on prices. With inventories continuing to build and demand weak, a strong dollar will likely cause oil prices to continue to sell-off.

Likewise, while Chinese demand for copper was up over 50% year-over-year in first five months of this year, China's real estate and construction markets remain very weak, and stories of buyer defaults in the bulk metal market, for commodities such as iron ore, are becoming fairly widespread. While the likelihood of continued strikes and natural disasters will likely prevent copper prices from falling significantly, a strong dollar should also put pressure on the Red metal in the near-term.

To conclude, policy makers and Central Banks seem open to the idea of new fiscal and stimulus measures. Still, political opposition to major new fiscal or monetary initiatives remains high in the U.S., and German opposition parties continue to oppose Euro Bonds and other stronger action Germany and the ECB could take. While the Fed and ECB are waiting for political actors to set the agenda, with the U.S. presidential election getting started, and many European nations divided, major new stimulus and bailout actions remain unlikely in the near-term. With the economic data deteriorating at an increasingly alarming pace, and summer typically a period of seasonal weakness for equities, traders and investors will likely wait to initiate long-term positions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.