Thursday, August 12, 2010

The Stock Market Is In Limbo—Which Way Will It Go?

An incredibly positive corporate earnings season in July has helped the market to discount immediate fears of a possible double dip recession. The strong corporate earnings reports, however, had to battle Ben Bernanke’s very dovish remarks, as he emphasized the slowing recovery in the U.S. and raised the possibility of Federal Reserve instituting further quantitative easing measures. Those bearish remarks by the Fed President regarding the possible future direction of the U.S. economy did cause equity markets to stall in the 3rd week of July, but now in the final week of the month, equity markets are again taking a shot at the HI’s from the month of June.

As the Dow Jones creeps higher it is going to face a tough test at the 10,600 level. This is the area where price reacted with a violent failure in June. Currently on the Daily Chart in the Dow Jones, we are looking rather bullish. Price moved from the lows of 9,600 in early July to a HI at 10,400 before it began a corrective move down to 10,000. Since hitting 10,000 last week, the Dow has been moving higher and we appear to now have a higher HI in place on the Daily Chart, which generally is a sign of continued bullish movement.

Where Is the Market Headed?

In Chairman Bernanke’s testimony before Congress, he made it clear that the economic recovery in the U.S. was slowing. Now, the market’s attention is going to be on U.S. economic data in order to help discern how bad the slowdown will be. First of all, investors must understand that a slowdown is okay. In fact, after the rapid rebound from the lows of March 2009, the global economy is due for a small slowdown. What we don’t want to see, however, is a contraction in growth. Slow growth is okay, while contraction is very dangerous. If economic data begins to show economic contraction, then the threat of a double-dip recession could become very realistic, and the market would have a very difficult time moving higher.

However, if economic data coming out during the next few weeks shows that the U.S. economic recovery is still moving forward, then we should see further gains in the equity markets. All attention is currently set on the Advanced GDP figure that will be released on Friday July 30th. The figure is expected to come out at 2.5%, which is slightly lower than the previous quarter. The lower projection is in line with Bernanke’s remarks concerning a slowdown in the economic recovery. If this number comes out lower than 2.5%, it could mean very big trouble for the U.S. equity markets. If the number comes out 2.25% or less, expect a large sell-off in the U.S. equity markets. If could get very ugly.

Currently, Mervyn King in the England and Ben Bernanke are both warning of very difficult times in the near future for the global recovery. Jean-Claude Trichet at the European Central Bank, however, is not as dovish as these other two. The fact that we have two of the three most powerful economic and financial leaders in the developed world very bearish on the global economic recovery is not a very good sign for the U.S. equity markets. Although the markets are fighting to move higher at the moment, it could all change very quickly if U.S. economic data begins to surprise to the downside. Market participants are fully aware that the recovery is slowing, and as we stated earlier, that is okay. The problem is going to be when the data begins showing greater downside risk than is currently being projected. If that happens, brace for a strong equity market sell-off and volatility to increase in the currency trading market.

This article is a contribution from:

Martin Short
Site Manager