Market Perspective for May 5, 2014

Once again we enter the week looking for the major indexes to reach new highs. Last week the Dow Jones Industrial Average hit a new record, highlighting the bullish trend in the market. Over the coming days we are watching to see if the other indexes will follow Dow upwards.  If they do, it will signal that the choppy sideways trading we’ve seen in recent weeks is over and a new rally is underway.

Adding to the stakes is the rally in the 30-year and 10-year treasuries. The 10-year treasury yield has been trending sideways since July 2013 and is on the verge of hitting its lowest yield in 2014, below 2.60 percent.

Stocks remain in a bullish trend and bonds are not yet breaking lower. One possible factor weighing on bond yields is China’s economic slowdown. The manufacturing PMI from HSBC showed China’s manufacturing sector remains in a mild state of contraction. Real estate sales were dismal over the May holiday and this is a big month for maturing trusts in the real estate sector. Due to the importance of this sector in the Chinese economy, any trouble could keep GDP growth suppressed for at least the current quarter.

With the Chinese story in mind, the rally in bonds may be due to global investors who are concerned about another outbreak of deflation. China can export deflation via a weaker currency and lower prices. If this were to occur, it would be positive for U.S. bond prices.

A modest slowdown in China, coupled with deflationary forces, would allow the Federal Reserve to exit or increase quantitative easing without fear of rising interest rates for the foreseeable future. Which way the Fed moves is hard to guess: they do want to exit from quantitative easing, but if China’s slowdown leads to more deflation, they may want to pursue higher inflation with more asset purchases. Either way, weakness in China would carry over to emerging markets, keeping U.S. assets attractive for international investors. Even more, lower interest rates could benefit dividend paying shares.

Whether we see more or less quantitative easing, the trend is in favor of equities. Until there’s a clean signal otherwise, it pays to stick with the stocks. In either the case of more or less quantitative easing, there’s a bullish argument for stocks. Speaking of the economy, while Q1 GDP was weak, current data remains solid and the economy powered through similarly weak quarters over the past 5 years. All signals point to continued economic expansion domestically.

Economic Reports: While there are some key reports, this week is far less important than last in terms of data.

As we saw late last week, data from March which came out after the GDP report on Wednesday caused analysts to cut their Q1 GDP estimates from 0.1 percent to negative 0.1 percent. (GDP is reported over three months, with revision becoming more accurate.) On Tuesday, the trade deficit will be reported and the consensus expectation is for a deficit of $39.8 billion. If this number is substantially larger or smaller, it could cause GDP estimates to fall or rise, respectively.

The other significant economic event of the week is Janet Yellen’s testimony before the House and Senate. No surprises are expected, but it is impossible to predict how traders will react; sometimes the market hands on a single word spoken by the Fed chief.

Earnings:  The bulk of earnings season is complete, with more than half of the S&P 500 companies having already reported earnings and more than 80 percent in terms of market capitalization. This week has some popular names reporting, but only a couple of large firms based on market capitalization.

The big blue chips are Pfizer (PFE), Anheuser-Busch (BUD) and Disney (DIS). Keurig Green Mountain (GMCR), Tesla (TSLA), Whole Foods (WFMI) and First Solar (FSLR) also report.

Oil exploration funds may see some volatility with several mid-sized producers reporting. They include: Anadarko Petroleum (APC), EOG Resources (EOG), Marathon Oil (MRO), Devon Energy (DVN) and Occidental Petroleum (OXY).

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