Month: May 2014

The S&P 500 Index climbed to a new all-time high on Friday, closing at 1,923.57. The Dow Jones Industrial Average, which is up 1.92 percent this year, is also on the verge of a new high, finishing out the week at 16,717.17. While the Nasdaq has been relatively weak for most of the year, during the month of May the Nasdaq rallied 3.1 percent and is now positive 2.12 percent year to date. Interestingly, the sub-index Nasdaq 100 is already at a new high. This indicates the Nasdaq has the strength to move higher and eliminate the last remnants of short-term bear resistance.

We have long expected the first quarter GDP estimate would be revised lower. Analysts were looking for growth to be approximately negative 0.5 percent, but the second estimate was even more disappointing announcement, falling to negative 1 percent. Even though the second estimate was worse, we also believed the market had already priced in the negative report. Moving forward, what is most important is the current Q2 GDP growth rate and the outlook for the remainder of the year. Many economists are still forecasting GDP will rebound strongly over the coming months.

One of the reasons for the weakness in GDP stems from an issue we discussed at the end of last year. In the third quarter of 2013, GDP growth was very strong due to a buildup in inventories. When the economy didn’t pick up as expected, the inventory overhang meant that companies didn’t have to produce as many goods to meet customer demand in the following quarters.

When GDP is calculated, inventory increases count towards GDP because a good was produced. When inventory falls, this subtracts from GDP. The large buildup of inventory in the third quarter of 2013 appears to have dragged on growth in the first quarter of 2014, and inventories fell. As a result of the drop in inventory, now there is the prospect of higher GDP growth in the coming quarters because companies will have to produce more to meet demand. Several investment banks have upped their Q2 forecasts: Goldman Sachs now forecasts 3.9 percent and Morgan Stanley forecasts a 4.2 percent growth rate this quarter. This is why the stock market indexes climbed to new highs when there was seemingly bad news about a contracting economy.

While this will be a light week for economic reports, the second estimate of GDP growth will be released on Thursday. Analysts have lowered their estimates to around negative 0.5 to 0.6 percent based on Q1 economic data. The first estimate indicated 0.1 percent growth at the end of April. A lower figure certainly isn’t good new, but stocks have already priced in the lower GDP figure. At this point, investors are focused on the current quarter and second half growth rates. If data continues to show improvement, it will be very good news for the market.

We saw some of that more timely data last week as the Markit flash PMI showed an increased rate of expansion in the U.S. manufacturing sector. The reading jumped to 56.2 in May from 55.4 the previous month. Any reading above 50 indicates growth. Additionally, Markit’s Economic Output index improved from 58.2 in April to 59.6 this month. This is the biggest increase in over 3 years. The Chicago PMI will be released this Friday and is also expected to increase in May, a sign that the economy is picking up.

The major indexes could use a boost from positive economic data. The S&P 500 Index and Dow Jones Industrial Average come into the week at or on the cusp of new highs. The Russell 2000 Index and the Nasdaq both bounced last week, but could stand to put more distance between themselves and their lows. Adding to the bright outlook coming into the week is the Dow Jones Transportation Index, which closed at a new high on Friday.

Oil prices have also broken out to the upside, though a further climb is necessary to hit a new high for the year. West Texas Intermediate Crude climbed above $104 a barrel on Friday with the closing high for the year just below $105. Energy shares had been strong until mid-April, at which point they started moving sideways in a very narrow the trading range. If the bulls take control of the market this week, look for energy to do well and set new highs.

Finally, the best returns from a rally over the next few weeks may come from small caps, which have struggled this year. Keep a close eye on these stocks as investors looking for value may bid up these oversold shares.

Economic Reports: The U.S. GDP report is the data highlight for the week. On Friday, Canada, India and Brazil all report GDP as well. Trade balance figures will come out over the weekend, with Korea scheduled to report on Saturday. Also on Saturday, the Chinese manufacturing PMI is due.

Earnings: Another week of retail dominated earnings. Abercrombie & Fitch (ANF), Costco (COST) and Dollar General (DG) are among the retailers reporting. Toll Brothers (TOL) will impact the home builder sector when it reports.

After several weeks of being caught in sideways actions, stocks climbed this week and the market took a solid step towards a bull rally. The S&P 500 closed at a new record high of 1,900.53.  The Dow Jones Industrial Average and Nasdaq also concluded strong weeks, up on the day 0.38 and 0.76 percent, respectively.  The Russell 2000 Index, which has underperformed this year, closed up 1.11 percent.

Many sectors are behaving well. Internet, biotechnology, Nasdaq and small caps are starting to outperform. Energy stocks haven’t broken out yet, nor have oil prices on the spot market, but oil futures are at new highs for the year.  If these gains hold and investors become a bit more confident, it could lead to a breakout and a more significant rally.

Although the evidence for a bull rally is increasing, these are still very small steps in the right direction. The market has been very calm now for several weeks and there had not been enough evidence to justify a bullish or bearish position for short-term traders. When this market finally breaks, we will know it because the direction will become clear.

Investors would do well to remain mentally prepared for either outcome, but long-term investors should remain on track with their long-term strategy, as an expected sell-off here would only be a correction. A new rally may unfold so quickly that investors buying in may do so too late.

Overseas, the economic picture has improved, but still remains cloudy for the near future. The flash PMI for China increased to 49.7 for May, but below a reading below 50 signals the country is still in contraction. Economists remain concerned about China’s deteriorating data coming from the housing market. The U.S. is not overly exposed to China, but if the country does experience a significant financial crisis, the global economy could be pushed towards a recession.

As for the U.S. economy, data was stronger this week. Home sales picked up and the flash PMI for the U.S. climbed to 56 for May, indicating further expansion. Manufacturing is a leading indicator and this strength remains a positive sign for the long-term health of the economy. Rising energy production in the U.S. is helping to keep manufacturing strong, as much of the technology that powers shale oil and gas production is produced domestically.

Rising energy prices are bad for consumers and the consumer discretionary sector. However, U.S. manufacturing may increase as energy prices rise as it becomes profitable to extract more expensive oil and gas. These harder to reach deposits require more capital investment and technology that is domestically sourced. In other words, as energy prices rise, more energy is produced here at home.  This could lead more job creation and spending moving from offshore to onshore.