The Corrective Phase Continues

Correction Remains Intact. Corrections are defined by a pullback of at least 10% from a prior peak. After peaking on April 23, the S&P has retreated by 12.5% through the close on Friday, June 4. Since the rally began in March 2009, the S&P has been void of a corrective phase, so arguably we were overdue. While at this stage it's impossible to forecast whether this pullback will lead to the resumption of a bear market (defined by a 20% retreat from a prior high), the macro fundamentals in the United States are solid enough to limit the downside risk from here and possibly become an upside catalyst at some point in time. The question remains how long before investors shift their focus back to the fundamentals in lieu of all the headline noise?

	Index	Closing Price 6/4/2010	Week Ending 6/4/2010	Year to date through 6/4/2010
	Dow Jones Industrial Average	9931.22	-2.03%	-4.76%
	Wilshire 5000 Total Market	11,018.27	-2.45%	-3.53%
	S&P 500	1,064.88	-2.25%	-4.50%
	NASDAQ Composite	2,219.17	-1.68%	-2.20%
	S&P/TSX Composite	11,569.61	-0.87%	-1.50%

Employment Report. The much anticipated May jobs report fell well short of investor expectations. The report was expected to show blowout numbers with some estimates calling for as many as 750,000 new nonfarm payroll jobs being added during the month. The fire was stoked by comments earlier in the week by U.S. President Barack Obama and a handful of Federal Reserve Board officials who telegraphed a strong showing. The Labor Department reported that nonfarm payroll in May rose by 431,000, well short of the 536,000 expected by economists. The nuts and bolts of the report showed that the U.S. government (Census) hiring accounted for the bulk of jobs while private payrolls only increased by 41,000. While economists expected a surge in census hiring, private hiring fell well short of the expected 180,000 jobs. While overall the report was a big disappointment and takes some shine off the recovery story, there were some glimmers of hope in the numbers. For example, both average hourly earnings and the average work week expanded during the month. In addition, temporary help services --historically a precursor to actual hiring-- rose for an eighth consecutive month. Also of note, since the beginning of the year, nonfarm payrolls have expanded by almost 1 million jobs, of which over half were in the private sector.

Political Tensions Heating Up. Saber rattling overseas (Middle East, North/South Korea) coupled with growing social acrimony stateside are adding another layer of uncertainty to the investment puzzle. Domestic flare ups are being sparked by the lack of progress in capping the oil well in the Gulf of Mexico and raising concerns over the long-term environmental as well as economic impact of the disaster. In addition, there remains a growing frustration with political incumbents and Washington's free-spending ways. This will likely be a key theme in the mid-term elections in November. While Republicans are likely to gain several seats, the growing discord for politicians on both sides of the aisle should make for much drama (and therefore investment uncertainty) over the next several months, in my opinion.

Europe. The crisis in Europe continues to weigh on investors' minds. While the issue is slowly falling off the front pages, the bottom line is things have yet to show much improvement. This was evident two Fridays ago when Spain's credit rating was downgraded a notch by one of the credit rating services. Also, late last week, Hungary indicated that talk of default is not an exaggeration. While Hungary is not a member of the monetary union, the heads up reignited concerns that the problems in Greece et al, may be starting to spread to other corners of European Union. Interestingly, the sovereign debt crisis (at least to this point) hasn't led to a further deterioration in Europe's economic conditions. This is likely explained by the neutralizing effect of the positive influence of a weaker euro. A weaker currency helps exports-driven countries like Germany (the eurozone's largest economy) by making its products more competitive in the global marketplace.

A Bumpy Recovery. While the weaker than expected jobs report definitely takes some shine off the budding U.S. economic recovery, other economic data last week confirmed the recovery is intact (albeit softening a touch). The recent choppiness of economic data is also a reminder that the road to recovery is very rarely a straight line and often contains potholes along the way. Last week, the Institute for Supply Management (ISM) reported that its Manufacturing Index expanded for a tenth consecutive month. While the headline number of 59.7 fell slightly from the 60.4 reading in April, the New Orders component held steady while the Employment Index rose to a six-year high. The ISM also reported that its Services Index was flat in May at 55.4. The reading was slightly below economists forecast of 55.6, but still signaled expansion in the Services sector (the ISM indices are diffusion indexes where readings above 50 signals expansion while below 50 signals contraction). On the housing front, the National Association of Realtors reported that pending home sales during the month of April rose 6.0% following the upwardly revised 7.1% gain in March.

Pending sales have risen by a total of 23% in the three months, highlighting the favorable impact of the first time home buyer's tax credit. While housing data has been very strong, the weekly mortgage applications information from the Mortgage Bankers Association coupled with the recently reported building permits data may be indicating that a sharp slowdown is may be in the works. While mortgage applications in the week ended May 28 rose by 0.9%, the purchasing index fell by 4.1% and now stands at the lowest level since April 1997.

Technical Tea Leaves -- A Pause to Refresh. Technical analysis (the study of price and volume trends) has been gaining momentum, in my opinion, as fundamentals are being pushed to the backburner. The S&P 500 broke below its 200 day moving average (dma) a few weeks ago, signaling a possible a change in the markets longer term trend. While the downside violation is a definite yellow flag, I maintain that the trend of the 200 dma --which is still rising--is arguably more important. While the punch back above the 200 dma (currently at 1106) would be views as a near-term win, with the recent spike in fear (VIX Index), the oversold nature of the markets and the sharp plunge in investor sentiment, it appears too early to call an end to the current rally. While many asset managers shrug off the use of technical analysis and consider it market witchcraft, traders tend to use technicals to help shape and define risk. Remember if enough eyeballs are focused on something then the event becomes important.