Market Perspective for May 23, 2014

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.

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