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DJIA Industrial Average

Weekly Commentary-July 26-July 30

Open: 10424.17

High: 10632.52

Low: 10327.37

Close: 10465.94

Change: 47.23 (0.45%)

RSI: 59

MACD (Delta): 12.3

Strategy:  The week remained largely listless for the US stocks, which kept searching for a proper direction and battling between better Q2 earnings and weaker economic indicators. The week closed with minor gains in the indices, as the markets are looking to take a shot upwards from improved economic indicators.

Commentary

Stocks closed the week with the best monthly gains in a year during July as investors cheered strong second-quarter results from an array of major U.S. companies. Dow Industrial gained closed to 7% in the month of July, albeit with subdued volumes.

The last week, however, did not see any pick up in the market activity, as the Dow Industrial Average closed with minor gains of 47.3 points, or 0.45% at 10465.94 points. The tech heavy Nasdaq Composite, however, shed 9.77 points, or 0.4% in the week.

The Q2 estimates for GDP were released on Friday, to 2.4% from 2.7% projected in the Q1. These were largely in line with the expectations.

On the jobless data front, the initial jobless claims filed for the previous week fell by 11,000 to 457,000 last week, according to the Department of Labor.

However, Durable goods orders fell 1% in June after dropping 0.8% in May.

A major dampener on sentiment came early in Tuesday, as the consumer sentiment for the past month fell to lowest since last November, making the buyers cautious.

There were reports floating around that the Fed officials had warned of a Japan type deflation pressure in US hitting in near future.

Dow component Exxon Mobil reported higher quarterly earnings and revenue thanks to an increase in oil prices versus a year ago.

Another Dow constituent Sprint Nextel posted its first rise in subscribers in three years, but also posted a wider second-quarter loss as it lost more lucrative customers.

Boeing was under pressure as its second-quarter profit fell from a year earlier, due to less airplane deliveries and defense revenue.

BP posted a huge quarterly loss of $17.2 billion due to costs connected to the Gulf of Mexico oil spill. The company also said that British CEO Tony Hayward will be replaced by American Robert Dudley Oct. 1.

DuPont reported higher quarterly sales and earnings that beat the estimates, due to higher prices and increased demand.  The shares gained in the week.    

Pressure was also seen on FMCG stocks like Colgate Palmolive, Kraft Foods and Proctor & Gamble late in the week, since Colgate Palmolive could not match the analysts’ expectations for Q2.

The Week Ahead

Monday

Reports on manufacturing activity and construction spending

Tuesday

A report on June factory orders

July auto sales for car truck makers

June personal income and spending report

Wednesday

EIA Petroleum Status Report

ISM index of activity in the service sector for July

ADP July private sector employment report

Thursday

Jobless Claims Data

Friday

July unemployment report

DJIA Industrial Average

Weekly Commentary-July 26-July 30

Open: 10424.17

High: 10632.52

Low: 10327.37

Close: 10465.94

Change: 47.23 (0.45%)

RSI: 59

MACD (Delta): 12.3

Strategy:  The week remained largely listless for the US stocks, which kept searching for a proper direction and battling between better Q2 earnings and weaker economic indicators. The week closed with minor gains in the indices, as the markets are looking to take a shot upwards from improved economic indicators.

Commentary

Stocks closed the week with the best monthly gains in a year during July as investors cheered strong second-quarter results from an array of major U.S. companies. Dow Industrial gained closed to 7% in the month of July, albeit with subdued volumes.

The last week, however, did not see any pick up in the market activity, as the Dow Industrial Average closed with minor gains of 47.3 points, or 0.45% at 10465.94 points. The tech heavy Nasdaq Composite, however, shed 9.77 points, or 0.4% in the week.

The Q2 estimates for GDP were released on Friday, to 2.4% from 2.7% projected in the Q1. These were largely in line with the expectations.

On the jobless data front, the initial jobless claims filed for the previous week fell by 11,000 to 457,000 last week, according to the Department of Labor.

However, Durable goods orders fell 1% in June after dropping 0.8% in May.

A major dampener on sentiment came early in Tuesday, as the consumer sentiment for the past month fell to lowest since last November, making the buyers cautious.

There were reports floating around that the Fed officials had warned of a Japan type deflation pressure in US hitting in near future.

Dow component Exxon Mobil reported higher quarterly earnings and revenue thanks to an increase in oil prices versus a year ago.

Another Dow constituent Sprint Nextel posted its first rise in subscribers in three years, but also posted a wider second-quarter loss as it lost more lucrative customers.

Boeing was under pressure as its second-quarter profit fell from a year earlier, due to less airplane deliveries and defense revenue.

BP posted a huge quarterly loss of $17.2 billion due to costs connected to the Gulf of Mexico oil spill. The company also said that British CEO Tony Hayward will be replaced by American Robert Dudley Oct. 1.

DuPont reported higher quarterly sales and earnings that beat the estimates, due to higher prices and increased demand.  The shares gained in the week.    

Pressure was also seen on FMCG stocks like Colgate Palmolive, Kraft Foods and Proctor & Gamble late in the week, since Colgate Palmolive could not match the analysts’ expectations for Q2.

The Week Ahead

Monday

Reports on manufacturing activity and construction spending

Tuesday

A report on June factory orders

July auto sales for car truck makers

June personal income and spending report

Wednesday

EIA Petroleum Status Report

ISM index of activity in the service sector for July

ADP July private sector employment report

Thursday

Jobless Claims Data

Friday

July unemployment report

Let’s simply cut to the chase and look at momentum on $GLD the way I would an index or a stock.

Monthly momentum: Negative

Weekly momentum: Negative (but oversold)

Daily momentum: Positive

Take a look first at the Monthly Fibonacci projection for targets on GLD. As one can see on the chart, we are at a key Fibonacci projection level that was based on the June 2005 low to the March 2008 high. The 127.2% projection of that line is roughly $116.53, and, as I have stated quite a few times on Vince Rowe’s show, the 1.618 projection of that line is still $136.96 (or right around $137).

Is that target now impossible to hit because sales of gold have softened and signs of deflation are contracting economic activity? A lot depends on what you think of Asian gold demand should prices remain soft in the near-term, and whether or not the Euro rally will continue. If the dollar weakens further and buyers return to the gold market, GLD (and gold basically) are simply trading at the low end of the tiny channel I drew on that monthly chart. A weaker dollar would mean at least a source of stability for GLD pricing, and perhaps even a rallying point for it and other U.S. dollar denominated assets.

I could probably convince myself either way and that is the dilemma traders, banks, jewelers, fund managers, you, and I have to face in this shaky and confusing economic environment.

What is most interesting is that since daily momentum is positive, it also appears that we have a bullish XABCD Fibonacci pattern that has completed (look at this chart). It is not a bullish Gartley pattern because the B to C line is not a 0.618 retracement of the A to B line, but the 0.618 retracement did hit a support area as momentum (expressed as CFGMO in the daily chart before, turned positive).

The daily neural net model did issue a buy 3 days ago, but here is the catch. It is highly likely that the swing trade is a 3 to 5 day swing trade that might (and probably should) end on Thursday. Why?

1) It is likely that the first target will be reached very quickly. If one looks at the 0.618 retracement of the C to D leg, one would come up with a target of 116.82, but there is a realistic chance (given that daily momentum is positive), that a gap fill at 119.13 is quite possible. The rapid decline in GLD (and gold) could be made up quickly as those bearish candles happened rapidly and can be erased rapidly. Take a quick look at this daily chart to see the measurement of the targets.

2) Employment numbers hit Friday (Non-farm payroll). That number will be sizably negative (because of loss of census jobs, but private payroll jobs will also be reported (est. to be a 90,000 increase). That is likely to cause a spike one way or another in the U.S. Dollar and its pairs in forex and currency futures trading, and that by proxy (since gold and GLD are priced in dollars) will cause a likely spike one way or another in the price of GLD and gold.

That means there are two potential scenarios for gold prices:

Unemployment is expected to be 9.6 % in the US. If for some reason unemployment is higher and the private payroll jobs substantially lower, we could see the US Dollar perhaps weaken against foreign currencies like the Euro (EURUSD). That would put upward pressure on gold prices (as a cheaper dollar would buy less gold), and the GLD rally could continue. A rally back to 122.79 is possible, and if the demand story for GLD holds up, that longer term Fibonacci upside target of 137 is still a remote possibility by spring of 2011.

3) If not, and the dollar strengthens (and by no means is this certain either), Gold could indeed correct back to 108.80 by September 30, 2010 roughly, and even back to 100 by spring 2011. See this chart.

Why do my predictions seem rather tame compared to some that I have seen?

1) I try to base my predictions on the patterns and momentum that exist in the market at this CURRENT time. They might not be perfect, but they ARE measurable. They have also been statistically solid over time.

2) I am still being biased to the upside based on the world demand for gold particularly in Asia. (You have to be a member of Seeking Alpha to read that article, but its free to join, so why not?) Gold is as much being purchased for jewelry and personal use as it is for an inflation hedge. Institutions will buy and sell it to stabilize their cash positions as a hedge. As long as demand is up and it outstrips supply, the price bias should be bullish.  Doesn’t necessarily mean it will be, but it should be.

3) The two major world currencies are in the hurt locker because of sovereign debt and entitlement spending issues.  It boils down to which garbage bag do you want to carry your liquid assets in? Will it be the U.S. dollar garbage bag, or will it be the Euro garbage bag?

 The advantage of the U.S. Dollar garbage bag is that it can easily print its way out of its debt problems, while the Euro cannot, or at least, not easily. Since the U.S. Federal Reserve can print (and LOVES to print) fiat currency, that is a bullish mark for the devaluation of the U.S. dollar. That is, it is bullish for gold and GLD if that trend continues. If China and other companies call our bluff and want their money back, our rates go up and that sets off a huge chain of bad events. That’s the downside of the U.S. Dollar garbage bag. Fortunately because of the manufacturing/consumption symbiosis of China and the U.S., the jawboning that falls just short of bluff calling continues. If the U.S. continues its profligate debt accumulation, however, the day of reckoning gets ever closer.

The real downside of the Euro garbage bag is that the sovereign debt problems continue to be a real concern, and it seems only Germany has the economic strength to hold the Euro-zone together.  Stress tests may have calmed investors and institutions for awhile, but there are more debt issues around each corner, and only so many ways to plug the holes in the debt dyke. The Euro-zone has little in its arsenal other than austerity to fix its debt crisis and is slowly implementing it. That will be its greatest challenge for the next decade or two. For that reason, the Euro could ultimately weaken, or perhaps even dissolve if all of these problems are not fixed.

Having said that, which way do I think GLD will go?

1) Through Thursday, I think GLD could go anywhere from 116.82 to 119.13.

2) After that, one of those two scenarios will likely play out. GLD will either hit 137 or fall back to at least 108.80 and perhaps back to 100. That bullish XABCD pattern would be the genesis of that new rally, and the low hit by GLD over the last few days would redefine the long upward channel that started during late 2008.

What do I think are the odds of either scenario happening? I have not one clue, but I do believe it will take until after traders get back into their seats post-Labor-Day for any real directional trade to happen, barring some critical world event (which I cannot forecast).

I think most people are feeling a bit like Merle Haggard did in 1974 (a year with another rather harsh recession) when he sang this song. Should employment numbers not signal growth, many U.S. employees will be wondering if they can afford Christmas cheer, let alone gold. That would also force rates to remain low, something that would tend to weaken the U.S. Dollar relative to other currencies. That too, would be net bullish for GLD and Gold.

I do not have a crystal ball, all I can do is react to patterns and trade them Currently, there is a long trade with a maximum terminus around 119.13 on GLD, which has a ratio of dollars profit to dollars lost of 1.60/1 and has 71.1% profitable trades with a five year track record with 54 out of 76 winning trades. After that, only time will tell.

If I knew the real answer, I could be drinking all the free bubble-up and eating that rainbow stew until I pop.

Let’s keep our eyes on GLD. We are at a pivotal moment in its trading history, I think.

The latest economic data have surely warranted a downward revision in the Federal Reserve's assessment of near-term economic performance. It therefore might be a good time to review the steps the Fed could take if it wishes to provide further economic stimulus.

One option that has been discussed is lowering or eliminating the interest that the Fed pays on deposits that banks maintain in their accounts with the Fed. These accounts typically amounted to about $10 billion in normal times, but have grown to over a trillion dollars since the Fed began paying interest on reserves in the fall of 2008.

Source: FRED

But Dave Altig isn't persuaded that eliminating interest on reserves would make much difference. He notes that the gap between what banks can earn by leaving the funds idle in their accounts with the Fed at the end of the day (0.25%) and a used car loan (about 8%) is so large that increasing it another 25 basis points by eliminating the payment of interest on reserves really wouldn't make much difference for banks' incentives to make this kind of loan. Instead, Dave endorses the conclusion of Barclays Capital's Joseph Abate:

If banks didn't get interest from the Fed they would shift those funds into short-term, low-risk markets such as the repo, Treasury bill and agency discount note markets, where the funds are readily accessible in case of need. Put another way, Abate doesn't see this money getting tied up in bank loans or the other activities that would help increase credit, in turn boosting overall economic momentum.

But Dave doesn't quite finish the story. If I as an individual bank decide that a repo or T-bill looks better than zero, and use my excess reserves to buy one of these instruments, I simply instruct the Fed to transfer my deposits to the bank of whoever sold it to me. But now, if that bank does nothing, it would be left with those reserve balances at the end of the day on which it earns nothing, whereas it, too, could instead get some interest by going with repos or T-bills. The reserves never get "shifted into short-term, low-risk markets"-- instead, by definition, they are always sitting there, at the end of the day, on the balance sheet of some bank somewhere in the system.

The implicit bottom line in the Abate story is that the yields on repos and T-bills adjust until they, too, look essentially to be zero, so that banks in fact don't care whether they leave a trillion dollars earning no interest every day.

The essence of this world view is that there are two completely distinct categories of assets-- cash-type assets which pay no interest whatever, and risky investments like car loans that banks don't want to make no matter how much cash they hold.

But I really have trouble thinking in terms of such a two-asset world. I instead see a continuum of assets out there. As a bank, I could keep my funds overnight with the Fed, I could lend them in an overnight repo, I could buy a 1-week Treasury, a 3-month Treasury, a 10-year Treasury, or whatever. Wherever you want to draw a line between available assets and claim those on the left are "cash" and those on the right are "risky", I'm quite convinced I could give you an example of an asset that is an arbitrarily small epsilon to the right or the left of your line. Viewed this way, I have a hard time understanding how pushing a trillion dollars at the shortest end of the continuum by 25 basis points would have no consequences whatever for the yield on any other assets.

The way to do the same thing in a bigger way is of course to raise the implicit penalty on idle cash through inflation. Whenever I make this point, some readers respond that I am proposing to turn America into Zimbabwe or steal the earning power of honest workers. If I as a modest blogger face such reactions, I can understand the difficult public-relations tightrope act faced by the U.S. Federal Reserve. Notwithstanding, it is very clear to me that deflation can be quite harmful, and that particularly given our present circumstances, moderate inflation rather than deflation would produce a clearly superior real outcome for essentially all Americans of every walk of life. But how exactly can the Fed prevent deflation?

In addition to the proposals I outlined a few weeks ago, Arnold Kling adds the suggestion that the Fed could buy more foreign assets:

If the Fed announced a policy of "20 percent weaker dollar or bust," and proceeded to buy euros, yen, and other currencies, by golly, I do not think that private speculators would try to get in the way. And if foreign governments tried to get in the way, that would probably lead to some sort of worldwide monetary expansion that I imagine would make [Scott] Sumner happy.

A weaker dollar would of course not only prevent deflation, but would also help discourage U.S. imports, which I see as both a near-term drain on domestic aggregate demand as well as a profound long-run challenge.

But let me close with the same caution I offered when discussing this issue two weeks ago. There are limits to what we can expect monetary stimulus to accomplish, and the speed-limit sign I recommend that the Fed should observe comes from watching what happens to commodity prices. If a strategy of dollar depreciation begins to show up in significant moves in relative prices, I think that's an indication the policy has accomplished all that it could.

It's a mistake to ask too much of monetary policy. But preventing deflation is definitely something we should ask the Fed to do, and well within the Fed's power to achieve.

The rally of the last few weeks slowed as the week finished with a narrow doji for many of the lead indices. The bear flag highs remain resistance and the bulls challenge to break the intermediate-term bear trend. Volume dropped, reflecting a consolidation - not a sell off, to the slightly lower close on the week.

With the slowing in the up trend it might be a quiet couple of weeks. The watch areas remain Fibonacci retracements with the first test of 61.8% so far a success but two more remain to challenge on future weakness.

($SPX)

via StockCharts.com

The Nasdaq still has a bearish head-and-shoulder pattern to consider, although the July decline put this to the test.

Nasdaq

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Likewise for the Nasdaq 100, it has an alternative neckline which extends back to 2006 at 1,702.

($NDX)

via StockCharts.com

The Russell 2000 has a large trading void to fill. The void is made all the more enticing with stochastics well off oversold conditions; 614 support down to 592, the first Fibonacci level, are the watch areas.

($RUT)

via StockCharts.com

Breath indicators continued to trend more bullish. The NYSE Summation Index kicked in with a new Confirmed 'Buy' signal.

($NYSI)

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While the Percentage of S&P stocks above the 50-day MA is fast approaching overbought levels.

($SPXA50R)

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So while markets are slowing their weekly advance, supporting breadth indicators continue to expand in bullish strength. More importantly, there continues to be room for breadth indicators to rise which suggests markets will push higher soon. Bulls will need all of this underlying buying impetus to crack past 'bear flag' highs on kill the declining bear trend from April. 

The 2010Q2 advance GDP release has been covered by Jim, as well as others. [RTE/Izzo] [CEA] [FreeExchange/RA] [CR] [MA] The release was accompanied by an annual revision of data extending back to data for 2007Q1. This revision alters our understanding (or lack of understanding in the cases of certain people) of the evolution of this recession. Here are the points I gleaned.

Figure 1: Log real GDP from 2010Q2 advance release (blue), from 2010Q1 3rd release (red), and potential GDP from CBO (January 2010), all Ch.2005$, SAAR. NBER defined recession shaded gray, assumes trough at 2009Q2. 6'6% is the implied output gap (in log terms) as of 2010Q2. Source: BEA, various releases, CBO, NBER, and author's calculations.

First, it is generally unwise to make definitive statements such as Donald Luskin's September 14, 2008 assertion that "...anyone who says we're in a recession, or heading into one -- especially the worst one since the Great Depression -- is making up his own private definition of "recession." Figure 2 below shows the impact of the data revisions on growth rates.

Figure 2: Quarter-on-quarter growth rates SAAR, for 2010Q2 advance release (blue), 2010Q1 3rd release (red) and 2008Q2 preliminary release (green). 2008Q2 series in Ch.2000$. NBER defined recession shaded gray, assumes trough at 2009Q2. Source: BEA, various releases, NBER, author's calculations.

Then CEA Chair Ed Lazear's statement "The data are pretty clear that we are not in a recession" is slightly less egregious because he was speaking on May 8, 2008, before a lot of the weak data had been reported. And implicit in his statement is the point that he was referring to the data at hand. But of course he knew the data were going to be revised ... repeatedly. Anyway, you can see here previous revisions changing our understanding of the economy's course [1] [2]

Second, this is indeed the deepest recession since the Great Depression, notwithstanding Professor Casey Mulligan's assertions [3] [4]. Below in Figure 3 I plot the last recession against Mulligan's conjoined 1980Q1-1980Q3 and 1981QIII-1982Q4 recessions; I've normalized on peak dates rather than trough dates as Professor Mulligan does, but the change is not essential to the message [5] (you can replicate the Mulligan graph using the NBER dates here).

Figure 3: GDP normalized on peak dates/recession begin dates for last recession (blue) and C. Mulligan's 1980-82 recession (red). Source: BEA, NBER, and author's calculations.

To me, it is clear that this last recession was much, much worse than this 1980-82 "recession" Professor Mulligan alludes to. In addition, we came close to the 11 trillion (Ch.2000$) floor that he insisted we wouldn't breach (I calculate 2009Q1 GDP when expressed in Ch.2000$ was 11.378 trillion, using a conversion factor of 0.88648, as explained in this post.) And Professor Mulligan's October 2008 forecast was not conditioned on any stimulus package (It might have been conditioned on credit easing -- not sure on this point). In any case, it is possible that a future comprehensive revision will drive the GDP figure experienced in this last recession very close to his threshold. (By the way, we long ago blew through his employment floor of 134 million, in January 2009.

Finally, the revisions provide additional information regarding the amount of slack in the economy: namely the output gap is now bigger than we were given to understand before.

Figure 4: Log output gap from 2010Q2 advance release (blue), from 2010Q1 3rd release (red). NBER defined recession shaded gray, assumes trough at 2009Q2. Source: BEA, various releases, CBO, NBER, and author's calculations.

In 2010Q1, the output gap was 6% (in log terms) using the pre-annual revision data. Using the post-revision data, the 2010Q1 output gap is now 6.8%, using CBO's January 2010 estimate of potential GDP. (Presumably, CBO will revise its measure of potential GDP in light of BEA's annual revision, but I expect the impact will still be there). Given this, it is no wonder that inflation indicators are muted. [6] As I said, we should've had a bigger stimulus.

My last point is directly related to the impact of revisions. Imports were a "negative contribution" to GDP growth in an accounting sense. However, higher imports are suggestive of higher economic activity, contemporaneously or in the future. In particular, one might think of capital imports as being very much related to expectations related to satisfying future demand (either domestic or foreign). In this regard, I think it's important to observe that 46.5 bn (Ch.05$, SAAR) of the 92.5 billion increase in non-petroleum imports was attributable to capital goods imports.

Figure 5: Quarter-on-quarter real growth rates (Ch.2005$, SAAR) for nonresidential fixed investment (blue), equipment investment (red) and capital goods imports (green), calculated as log-differences. NBER defined recessions shaded gray; assumes last recession ends 2009Q2. Source: BEA, NBER, and author's calculations.

To the extent that investment is rebounding that's a sign of some optimism about the future on the part of the private sector; increased capital goods imports is a reflection of that phenonenon -- that's about the only positive I saw in the report. However, even that positive is tempered by the fact that equipment investment remains 8.7% (log terms) below peak levels in 08Q1. (Nonresidential investment is 16.9% below peak.). Of course, hewing to my thesis, there's a big caveat -- the import series are based on two months worth of trade data. When the June release comes out, we may have a different take on how imports -- including capital goods -- have grown.