An uphill coast or the next leg up?

Market observations for the week of June 14 to June 18, 2010

Claymore Investments, Inc. 23 June, 2010 | 10:55PM

The major market indices finished higher for a second consecutive week. The recent rebound in stock prices appears to reflect fading concerns over the fiscal issues in Europe, portfolio jockeying as we near the end of the second quarter, and the break above the technically significant 200-day moving average.

Technicals show improvement. As mentioned several weeks ago, the S&P 500 index fell below its 200-day moving average, a barometer used to determine the market's overall trend. Last week's strength managed to push the index back above the 200 and appears to have given the fence sitters a catalyst to re-enter the market.

While the push above the 200 is not necessarily an "all clear" signal, the action seemed to ease fears of a larger, near-term meltdown. In the world of technical analysis former resistance should now be viewed as a new level of support. Over the coming weeks investors will monitor closely the S&P 500's ability to hold above the 1108/1110 area and, if successful, will likely become a catalyst for additional upside.

The next major upside level on traders' radar screens is the 1140-area which represents the 50-day moving average.

European banks will be stress tested. In an effort to pacify investor concerns over the state of the European banking sector the European Union (EU) announced it will initiate a series of stress tests on the 25 largest banking institutions within the eurozone. The EU also agreed to publish the results of the tests by late July in hopes of renewing confidence in the beaten-down sector. A similar exercise was completed in the United States last year and ultimately helped shore up confidence in the U.S. banking system.

Euro gains on fading contagion fears. The euro has tacked on almost 4% since the closing lows reached June 7. Moves in a country's currency (either up or down) tend to be a very good barometer of investors' viewpoint on a country's viability and/or its economic outlook and policies. The recent uptick in the euro may be an early indication that investors are becoming more comfortable with the developments in the eurozone and policy makers' steps to remedy the situation.

Index Closing Price
6/18/2010
Week Ending
6/18/2010
Year to date
through
6/18/2010
Dow Jones Industrial Average 10450.64 2.35% 0.22%
Wilshire 5000 Total Market 11561.90 2.37% 1.23%
S&P 500 1117.51 2.37% 0.22%
NASDAQ Composite 2309.80 2.95% 1.79%
S&P/TSX Composite 11927.59 2.23% 1.55%

Last week, Spain was able to sell a total of $4.3 billion in 10- and 30- year notes and bonds. Demand for the paper was solid, helping ease contagion fears. In addition, despite a series of poor economic reports, all the major European stock market indices posted solid gains, a sign that stocks may have over-discounted the near-term risks.

Financial reform still pending. While the need to impose stricter standards on some parts of the capital markets is inevitable, the government's inability to clarify the regulatory process appears to be hampering investors' ability to evaluate the impact and determine the eventual winners and losers. This indecision is likely partially responsible for the recent bout of volatility in the market place. It is well known that Wall Street dislikes uncertainty.

While the regulatory bill may ultimately prove to be a negative for some financial institutions, Wall Street will likely figure out how to work within the new rule structure, however, they must know what the rules are before that can happen. With the Financials sector accounting for a 16% weighting in the S&P 500, let's hope clarity emerges soon.

On a positive note, an effort to politicize the U.S. Federal Reserve by installing a provision within the regulatory bill allowing the White House to appoint the president of the New York Federal Reserve was recently killed. The independence of the Fed remains vital, as a decision toward monetary policy should not be politically motivated. The end result of such a scheme would have likely resulted in a bias around election time that would likely favour politicians and not necessarily be in the best interest of the overall economy.

More cracks in the housing foundation. As expected, cracks in the housing market continue to appear. Last week, the U.S. Commerce Department reported that housing starts plunged by 10% in May while building permits fell for a second consecutive month. The fall in permits is especially worrisome as building permits are considered a leading indicator for the housing market.

While the plunge in housing appears to be a direct response to the expiration of the first time homebuyer tax credit, the question remains: What will it take to get buyers off the sidelines? With financing costs near record lows and housing prices coming down substantially, affordability doesn't appear to be the issue. In addition, with the seasonally strong spring selling period rapidly coming to an end, the probability of further downside risk in the housing market stands to grow.

Looking ahead. The focal point of the week ahead will be the two-day Federal Open Market Committee (FOMC) meeting on Tuesday and Wednesday. While the FOMC is not expected to make any changes in its interest rate policy, all eyes will be focused on the after-meeting communiqué for hints into the Fed's thinking. Of interest on the economic calendar will be existing home sales (Tuesday), mortgage applications and new home sales (Wednesday), durable goods and jobless claims (Thursday), and the final revision to first quarter GDP (Friday).

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Claymore Investments, Inc.

Claymore Investments, Inc.