Buyer exhaustion sets in

Market observations for the week of Nov. 8 to Nov. 12, 2010

Claymore Investments, Inc. 16 November, 2010 | 11:56PM

The major market indices finished the week solidly lower as investors monetized recent gains due to growing uncertainty in the marketplace.

The major market indices finished the week lower, reflecting renewed concerns over the financial health of the eurozone and fears that the U.S. Federal Reserve's quantitative easing (QE) program will have little effect on jumpstarting economic growth.

Despite the weakness, markets have generally shown impressive resiliency in the face of the growing wave of negativity. The weakness seemed to be more related to buyer exhaustion following the solid run over the past two months, as opposed to the start of a major trend reversal.

From a technical point of view, the U.S. market has a good cluster of support with the S&P 500 in the 1150-1200 area, and investors have been very respectful of these major support areas. In addition, with the recent signs of economic stabilization and anecdotal evidence that portfolio managers are underweight their equity benchmarks, the "buy the dip" crowd will likely keep a floor under stock prices.

On a more macro level, attractive valuation, easy monetary policy, solid earnings growth, low inflation and economic stabilization makes for a very equity-friendly environment and likely sets the stage for additional upside heading into the year-end.

The markets also appear to be waiting for clarity on the extension of the Bush tax cuts. News on that front could be forthcoming as Congress reconvenes this week. While the period between now and the end of the year is likely to be tagged as a "lame-duck" session, a decision on the tax cuts will likely be one of the few pieces of legislation that will get resolved. The outlook is far from certain; however, the most likely scenario appears to be a temporary extension for all income brackets. In other words, politicians are likely to "kick the can down the road" and deal with this issue when the economic backdrop is on firmer ground.

Index Closing Price
11/12/2010
Week Ending
11/12/2010
Year to date
through
11/12/2010
Dow Jones Industrial Average 11192.58 -2.20% 7.33%
Wilshire 5000 Total Market 12442.79 -2.13% 8.94%
S&P 500 1199.21 -2.17% 7.54%
NASDAQ Composite 2518.21 -2.36% 10.98%
S&P/TSX Composite 12749.24 -1.36% 8.54%

Headwinds

The recent rise in oil prices -- almost 18% since the end of August -- has resulted in a surge in gasoline prices. According to the American Automobile Association, the national average for regular unleaded in the United States rose to US$2.88 per gallon last week, the highest level since early summer. The rise in gas prices comes at an inopportune time as higher prices essentially create a tax on the consumer and therefore may result in a headwind to consumer spending. With the holiday shopping season about to kick off, this is an unwelcome event and something to keep a close eye on.

China

Also weighing on the market last week was speculation that China will need to raise interest rates to slow growth and cool inflationary pressures. China reported on Thursday that consumer prices during the month of October rose by 4.4% on a year-over-year basis, the highest level in more than two years. The Chinese government has been targeting an inflation ceiling of 3%, so the higher than expected rate fanned fears that a rate hike may be imminent.

This in turn, weighed on world markets as China continues to be looked to as the engine of global growth, and any slowdown would likely have a ripple effect. Interestingly, credit rating firm Moody's upgraded China's government bond rating to Aa3 from A1 and maintained a positive outlook, citing the underlying strength of the nation's economy.

QE-2: A sinking ship?

Last week there were growing concerns that the Fed's recently announced QE program will be ineffective in helping to spark economic growth in the United States. Conventional wisdom dictated that the Fed's announcement would put downward pressure on both the dollar and interest rates. Well, somebody forgot to tell the markets, as both interest rates and the dollar backed up last week. The strength in the dollar likely reflected a flight to safety rally in light of the growing problems in the eurozone. Whereas, the back-up in rates may have reflected the lack of communication from the Fed in regards to its scheduled buying activity (i.e. quantitative easing).

Could it also be that the chorus of naysayers are reading the market's reaction the wrong way? An improving economy and higher inflation -- the ultimate goals of quantitative easing -- would likely dictate an eventual rise in rates and therefore be a net positive for the dollar. If anything, the lessons learned from having a near-unanimous opinion (i.e. lower dollar/lower rates) is that the populist opinion is rarely the profitable one and that the markets will do the most obvious thing, in the least obvious way.

Economic data continues to lean toward stabilization

Last week, the U.S. Labor Department reported that initial jobless claims during the week ended Nov. 6 fell 24K to 435K. The report was better than the 450K increase expected by economists. The four-week moving average -- which helps smooth the week-to-week volatility -- fell to 446.5K, the lowest level since September 2008.

Meanwhile, the trade deficit narrowed in September as imports fell and exports rose to the highest level in two years. Also worth mentioning was the 5.8% increase in mortgage applications and the jump in optimism amongst small businesses, as reported by the National Federation of Independent Businesses. Rising confidence in the small business sector is vital as small businesses provide the bulk of job growth in the U.S.

Q3 earnings summary

Through Friday, 460 members of the S&P 500 have reported quarterly results, with overall earnings up 31.6% on a year-over-year basis. Excluding earnings from the financials sector -- which continues to benefit from easy year-over-year comparisons -- earnings are still up a solid 25.5%.

Of the companies that have reported, 71.2% have beaten analyst expectations while 20.5% have fallen short. The beat rate is significantly better than the historical 61% average. Revenues are up 8.5% (10.1% when excluding financials) so far in the quarter. When all is said and done, third-quarter earnings for the S&P 500, according to Bloomberg data, are expected to rise 29.8%. If that growth rate is achieved, it would mark the fourth consecutive quarter of 20%-plus growth.

Looking ahead

The economic calendar will be front and center this week with reports on retail sales, housing and inflation likely to take center stage. Third-quarter earnings reports continue to wind down as only 24 members of the S&P 500 are scheduled to release results. Fed heads will be out and about this week with over a half dozen speeches scheduled.

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Claymore Investments, Inc.

Claymore Investments, Inc.