Jim Farrish's  Instablog

The concerns relative to economic growth are still in play despite the market gains from Thursday. Throw in some global concerns relative to the same issues and we have the making of more worries near term. Today the headlines are full of comments relative to Greece and what many consider the eventual default by Greece on their sovereign debt. Germany and the European Central Bank are at a difference of opinion over Greece raising new concerns. The economic data showed a smaller than expected trade surplus from China and Britain’s industrial production declined more than expected, adding to the speculation that global growth is slowing and it is not isolated to the U.S. The news has futures lower today and dollar up slightly relative to the euro.

What are we watching as we end the week?
1) Bond yields for one. They are currently at support of 4.15% on the thirty year Treasury bond. A move lower would come from accelerating fear about the economy. The flight to quality game may very well be back in play despite all the talk about the decline of bond values due to rising rates. The threat of higher debt and inflation as a primary concern relative to holding bonds is being outweighed by the slow economic picture both in the US and around the globe. There are plenty of comments comparing the US to Japan which has seen interest rates remained low for decades. The parallels in debt accumulation and attempts by government to stimulate a stagnant economy. For now bonds remains one of the more attractive sectors for money even with the low yields.

2) Gold and other commodities. The outlook for growth in gold prices are positive, but the pace of growth is likely to be much slower than some would like. Our outlook is for $1600 by year end which is only 3.5% from current levels. The volatility along the way could produce better returns in trading the metal, but the inflation play is dimming and the fear motivation is pushing money towards Treasury bonds again. Agriculture, in many ways, has the same challenge. The demand picture is not playing out as quickly as some expected. Thus, we should see modest growth of 3-5% over the balance of the year with more volatility. Crude oil is back at $100 and it seems content to stay in this range for now. The outlook was for $120 by year end, but if the economies continue to slow that may not happen. Thus, volatility and speculation will play havoc on the price day to day.

3) Leadership. The lack of leadership is the more appropriate statement currently. Scanning the ten major sectors of the broad market shows no real leadership. The previous leadership from the defensive sectors (healthcare, telecom, consumer staples and utilities) has taken a break. They are finding some near term support and that is what we are researching currently. Do they bounce and resume their leadership or role over along with the losing sectors? Thus far the pullback is just that, but further weakness would only add to more downside in the sector as they break the next levels of support. The financials, technology and industrial sectors have been a drag on the broad markets breaking lower. We wrote yesterday about the potential opportunities long term in the financial sectors. They did bounce nicely gaining more than 1.5%. We are not in the sector currently, but continue to scan for potential plays. Technology, energy and basic materials are trading sideways not adding any upside or leadership for the broad markets. Thus, leadership is hard to come by and the outlook is not improving currently. Be patient and let the leadership redefine or define itself.

Overall we have to remain patient. I know that is a repetitive comment, but forcing trades isn’t prudent in the current market environment. Looking longer term, the biggest question mark comes relative to growth. Where will it come from and when will it materialize. If Mr. Bernanke and friends are right and the fourth quarter is the tme period we can afford to be patient and let it play out before putting capital at risk without justifiable rewards.

The economic indicators have been pointing lower over the last six weeks and with the move has come renewed concerns about growth looking forward. The projections for a second half rally are still the hope of many economist, but the realities are mounting against those projections. With reality comes selling in the equity markets and if the reality sparks fear we could get panic selling. All the more reason to focus our portfolio and look at what is taking place in the broad market as well as the major sectors.

Financial stocks have been struggling all year. The sector is down 4.3% year-to-date and 11.3% from the high in February. We have discussed the issues facing the broad markets since the attempt to move higher in May, but the financials have been in a methodical downtrend since hitting their high in February. The fundamental data continues to show weakness in both the balance sheet assets and willingness to increase lending. Banks have been very conservative in their approach to lending. In addition they have been under increased regulatory pressure as well as uncertainty to what new regulations will be adopted or passed by Congress. The witch hunt by politicians has not helped, nor has the public perception or opinion of banks. Bottom line, the sector is in trouble and the trend is accelerating to the downside.

Whether the current activity is driven by fear or a lack of willingness by the consumer to borrow or use credit, the facts are simple to see on the chart below of the Dow Jones US Financials Index. Bank stocks have underperformed the S&P 500 index and they are a catalyst currently on the downside. The chart reflects the recent selling acceleration in the downtrend and all support near term has been broken. Technically the sector is in trouble and has been for some time. Financials are acting as the catalyst to the downside for the broad markets. 270 is the support level for the index and it will be important short term relative to how far the sector falls.

The Treasury bond activity has shown an equal worry relative to the future as interest rates have declined and bonds have risen. The chart below of TLT, iShares 20+ Year Treasury Bond ETF shows the rise in bond prices. Taken in conjunction with the chart above you can see the worry in action by investors. Does this mean stocks are going to correct near term? Not necessarily, but it is a big warning sign for investors. Money is rotating away from risk/growth stocks and into gold, cash, bonds and other defensive sectors of the market. If the fear level rises you will see more money flow into bonds and cash. Watch to see how this plays out. Currently the VIX index is still low with no signs of panic selling.

The move below 1300 on the S&P 500 index is a big negative for the broad markets. Throw in the push lower in financials and flight to quality into bonds and you add another negative to the outlook. The pieces are falling together for a correction in the broad index, but for now we are looking at the 1250 ish level to hold support on the downside short term. If the fear factor grows disproportionately, we could go lower. For now we play the downside and watch how the investor reacts short term. Don’t get overly zealous about being short the market. Take it one day at a time and follow the trend.