Stocks Outlook – Market Stalls as Economy Hits ‘Soft Patch’

by Anthony Mirhaydari | March 23, 2011 6:59 am

Stocks Outlook – Market Stalls as Economy Hits ‘Soft Patch’

After last week’s dramatic selloff — with the S&P 500 losing 3.6% culminating with a washout on Wednesday — the stock market today[1] shows bulls have managed to string together a nice relief rebound rally. Monday marked the third straight up day. So that’s it right? With Japan’s nuclear disaster coming under control and Libya’s airspace filled with Western fighter jets, are stocks ready for another big uptrend?

Not quite. There are issues with the recent rebound. It came on light volume and disappointing breadth — a sign that investors still aren’t excited about stocks at these levels. And on all three days most of the gains came in the opening minutes of trading. The lack of intra-day follow through points to a lack of enthusiasm. Most importantly, key sector groups that have led the decline — technology and semiconductors — continue to lag badly.

Various technical and momentum indicators suggest this was a temporary reprieve within a medium-term downtrend — a downtrend that’s being powered by indications economic growth is set to slow.

anthony12 Stocks Outlook   Market Stalls as Economy Hits Soft Patch

To be sure, investors are selling heavily. According to UBS, its client flow data shows that U.S. clients were net sellers of both domestic and foreign equities for a fifth straight four-week average period. The heaviest selling is being seen in financial and technology stocks.

Soft patch ahead?

UBS economist Andrew Cates is worried. He finds that “evidence has accumulated in recent weeks to suggest that global growth may disappoint in the period ahead” at a time when growth expectations are very high. Economic forecasts, keyed off of leading economic indicators which are now at levels “that are not typically sustained” in Cates’ words, will have to be revised downward.

anthony22 Stocks Outlook   Market Stalls as Economy Hits Soft Patch

You can see this in the chart above, which shows just how extended the UBS Global Growth Surprise Index is as recent data has beaten analyst expectations. This is not unlike the situation seen last April just ahead of the multi-month market swoon as unrealistic expectations were dialed back.

The factors supporting a softer patch of growth includes fading industrial production as overstocked inventories adjust, slower momentum from China, higher oil and commodity prices, and tighter global monetary policy.

anthony3 Stocks Outlook   Market Stalls as Economy Hits Soft PatchOf all the factors, I believe inventories will be the most important in the months to come since industrial production has been a rare bright spot given still moribund consumer spending and job market gains.

Levels of inventories for both corporations and countries (reflected through purchasing managers’ indices) have increased at robust rates since 2009. Inventory levels are a good leading indicator of overall economic activity, as they signify the aggregate amount of confidence in future market activity for firms and nations. Now, global inventories have swelled to extremely high levels.

However, given the focus on political revolutions happening in the Middle East, along with the sudden halt in production by industry leaders such as Sony and Toyota, experts expect inventory levels to decrease, causing a pause in growth as factory activity slows.

Until the clouds of uncertainty lift, stocks will continue to face selling pressure. I’ve recommended my newsletter subscribers focus on key short ETF positions including the UltraShort Semiconductor (NYSE: SSG[2]). For the risk takers out there, consider an option play on the PowerShares QQQ Trust (NASDAQ: QQQQ[3]) given the sustained weakness in the Nasdaq’s tech-heavy issues. The liquid April $54 puts (.QQQQ\11P16\54.0) look attractive.

Be sure to check out Anthony’s new investment advisory service, The Edge. A two-week free trial has been extended to Investorplace readers. Click the link above to sign up. The author can be contacted at anthony@edgeletter.com[4]. Feel free to comment below.

Endnotes:
  1. stock market today: http://investorplace.com/hot-topics/stock-market-today/
  2. SSG: http://studio-5.financialcontent.com/investplace/quote?Symbol=SSG
  3. QQQQ: http://studio-5.financialcontent.com/investplace/quote?Symbol=QQQQ
  4. anthony@edgeletter.com: mailto:anthony@edgeletter.com

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