Predicting the market’s next move based on recent news is often futile. There are times when the market reacts positively to good news, and there are times when good news is bad for the market. Likewise, bad news can also send stocks in either direction. Then of course, there are times when news sends the market in one direction only to have it soon reverse course and head the other way.
Last Friday, the Bureau of Labor Statistics released its September employment reports, and by most accounts, they were the best reports in months. The headlines shouted an unemployment rate of only 5.9% and trumpeted the creation of 248,000 new jobs. The market was elated, and the Dow Jones Industrial Average gained 208 points for the day. Digging deeper, the reports show the real reason for the dramatic 0.2% drop in the unemployment rate was that 315,000 citizens left the labor force. Despite the labor participation rate hitting 62.7%, its lowest level in three decades, the market focused on the good news and shot higher.
This action was in contrast to much of the past year when the market seemed to prefer negative economic news. In previous months, a bad economy implied the Fed would keep stimulus efforts in place longer, which would benefit stocks. Additionally, good economic reports often led to the conclusion the Fed might soon remove stimulus, and in turn affect stocks negatively. It now appears that last week became a turning point. The bad news is good environment turned to one where bad news is actually bad (and good news is good).
This new environment was put to a test this week, and it initially appeared to be passing. Unfortunately, the change came at the wrong time because the news was overwhelmingly bad, swamping out the short-term news from the employment report. One of the big culprits behind this week’s selling activity was the decline of global growth forecasts. Yesterday, the IMF raised its odds of a Eurozone recession to 38% and lowered its 2014 global growth outlook to 3.3%. Germany had been providing a solid base in the Eurozone but saw a 4% drop in industrial output and 5.7% dive in manufacturing orders during August. The Dow plunged 272 points in response.
Today, the Fed released its September FOMC meeting minutes, and the Dow roared 274 points upward. It appears the Fed also lowered its growth forecast due to the higher dollar and global weakness. However, the market’s positive reaction suggests we may have already reverted back to a bad news is good environment. Be careful out there, especially when trying to gauge the market’s reaction to economic reports.
The sector rankings have taken on a full-defensive posture. The traditional defensive trio of Health Care, Consumer Staples, and Utilities top the list. Additionally, these three are the only ones able to muster a positive momentum reading, as the other eight are all in the red. Health Care extended its time at the top to six weeks, and although it still has a slight upward trend, investors need to remember that is not a guarantee of profits. Being the top ranked sector often means losing less than the others. Consumer Staples climbed a notch to second, and Utilities jumped four spots to third and flipped from red to green in the process. Technology fell two spots to fourth and Financials slid to fifth. They are the only two sectors that moved from positive to negative trends. Telecom held steady, Consumer Discretionary gained a spot, and Real Estate climbed two places. Along with defensive sectors controlling the top of the rankings, the cyclical sectors appear to have a grip on the bottom. Industrials, Materials, and Energy trail the market, with Energy on the bottom and registering a steep negative trend.
You can look as hard as you want, but you won’t find any changes in the relative ranking of the style categories versus last week or the week before that. They moved into a defensive posture two weeks ahead of the sector categories and maintained that stance again this week. Mega Cap sits on top and is the only style in the green, although that status appears to be in jeopardy. The three Large Cap categories were clinging to positive trends a week ago, but they have now succumbed to the downside. Mid Caps are in the middle, and their negative trends have intensified. There is a noticeable fall-off in momentum values between the Mid Caps and Small Caps. Small Caps have broken below their May support levels, and the past twelve months of price action looks like a long-term topping formation.
A week ago, the U.S. was the lone remaining global category that had not fallen victim to negative market action. This week it lost that uniqueness, although it was able to hang on to its top ranking. With all categories now in the red, our relative strength ranking becomes more of a relative least weakness ranking. China’s price action was stable compared to other categories, allowing it to move up to two places to second and push Japan down to third. World Equity had third place all to itself a week ago but now has to share it with Japan. Latin America bucked the overall negative trend with a huge upside move. With the first round of elections now out of the way, Brazilian stocks soared and helped Latin America jump five places higher. Latin America’s strong showing and China’s relative stability helped pull Emerging Markets up three places to sixth. Canada and EAFE were two of the casualties resulting from the improvement in developing markets. Pacific ex-Japan improved two spots after spending the last two weeks on the bottom. The U.K. and Europe fell the hardest, dropping three places each to land at the bottom.
“This is a serious situation and it’s complicated by the sanctions between Russia and Europe and the uncertainty for business. The risk of recession in Europe is sizeable.”
Allen Sinai, Chief Economist at Decision Economics, 10/7/14
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