SUMMARY:
 - US debt rating still AAA, but outlook dropped to negative. Not the first time for us or others.
 - China raises bank reserve requirements again
 - Oil CEO says oil to trade less than $100/bbl by July
 - SP500, NASDAQ test February low support, bounce nicely.Â
 - Leadership ignores the debt issues, goes about its business.
 - Earnings taking front and center, start decent but TXN disappoints after hours.

MARKET SUMMARY

Debt outlook downgrade finally acknowledges reality, likely doesn’t change the politics.

You could see it coming.  Massive debts, spending out of control, the parties unable to agree, submitting diametrically opposed budgets (well, at least one was submitted) based on diametrically opposed theories of governance.  Was it the S&P downgrade of the US debt to outlook neutral while maintaining the credit rating at AAA?  No, it was the political nonsense that ensued. 

The President called S&P’s actions politically motivated, insinuating the timing was such that S&P interjected its views to influence the deficit debate.  The irony of this statement literally drips.  Sure S&P, like many, sees the handwriting on the wall and knows major steps, not raising taxes on the rich and not touching entitlements, have to be taken.  S&P, however, is one of the three ratings agencies anointed by the federal government to keep ratings on the US debt among others.  Thus S&P is very LATE in coming to the party, moving well behind what everyone already knows.  S&P waited and waited for the feds to do something, and finally it could not wait any longer and retain any shred of the little credibility it and the other ratings agencies have left.  And of course when it moved it took the smallest step it could take, changing the outlook. 

Still the President was miffed that an agency the feds crowned had the gall to act on his watch.  Pretty much a nightmare scenario for an administration, having the watchdogs of debt and credit judging your administration’s (as well as those of prior administrations) policies as profligate enough to downgrade the outlook.

Prognosis Negative?

Excuse the reference to Seinfeld, but judging from the response of the financial stations and others I had to use a rather dramatic yet comical reference.  While the move is an important step in the progression, everyone knows the problem already.  Hardly a surprise; it’s just when harsh reality slaps you in the face it stings a bit even when you see the glove coming.

But is it kryptonite for the market?  Stock futures dove on the news.  Stocks opened lower and sold off 2%.  By midmorning, however, stocks started back and indeed held the move into the close. No index turned positive but they sliced their losses after SP500 and NASDAQ tapped the February lows on the session low. That low was a targeted support level for us and it performed as we felt it should.

More than that, you can look at recent history to see market responses to this kind of action.  Almost two years back the UK suffered a similar outlook downgrade and its main stock market sold off similar to ours on Monday.  In seven days, however, it had recovered its losses. 

First time kissed?

Further, this is not the first time the US debt outlook was downgraded.  Back in 1996 a outlook negative label was slapped on the US when the republican controlled Congress refused to up the debt ceiling.  The ratings agencies panicked, and feeling they missed something downgraded the credit outlook. 

The US stock market spent two-thirds of 1996 moving laterally, basically consolidating a big upside move for the entirety of 1995.  Once the stock market digested the issues from 1996, just one of which was the debt issue, stocks shot higher once more. 

Of course that move was in large part aided by the overly loose monetary policies of the Greenspan Fed, but hey, we have an overly loose Fed right now.  If the money is there the market will rise. 

Slow timeline.

What does the S&P action mean?  In two years it has a 33% chance of lowering the US   AAA credit rating.  That from the horse  s mouth even as S&P says that neither the Ryan budget or the President  s loose outline of ideas he will and won  t accept do enough to impact the deficit. 

S&P is right: neither will eliminate the deficit, they will only slow the growth of the deficit through the next decade.  Even assuming 3% GDP growth, S&P says that the deficit would still be 86% of GDP by 2018 even under the Ryan plan (it would reach balance in 2040, but of course the government cannot add for that long). 

The Market’s Response:

The market action Monday in the face of this news suggests that the easy money fix as in 1996 is still the case as the indices bounced off of support and many, many leadership stocks that we have on the report paid no heed to the news, going about their business and working on some really nice bases.  We took our SPY put play gains and even picked up some upside as stocks tested and started to recover.

TUESDAY

Housing starts and permits are out in the morning. Last month they were higher but they had no real impact on the market.  Housing is going to be in the tank for still some time to come and the market pretty much has that factored in.

Earnings are the real driving force though some decent results Monday were usurped by the S&P debt downgrade.  After hours TXN disappointed and was lower, but the coattails were not very long looking at stocks in the chip sector in general.  Techs were holding up overall decently.  Big boys such as IBM are out after the Tuesday close and IBM will be a tell on Japan and its economic impact as was TXN. 

Outside of earnings the market has made a good test heading into the meat of earnings season with SP500 and NASDAQ both tapping one of our key target support levels at the early February low.  For a continued move higher to take on the February peak this is an important level to hold.  The Monday action was solid at those levels, and as noted many leading stocks, many on the report, demonstrated good action in the selling as well.  If the market is going to move higher near term, this is where it should do so.

Question is whether it tests further, can continue holding, then get the earnings guidance it wants to hear to drive back up to the February peak.  Again, that high is our next target; we are not necessarily looking for a breakout over that level.  Taking it a step at a time at this point, but there are many quality stocks in position to move higher and we anticipate riding those toward that high.  A modestly lower open off of TXN earnings can give us good entry points for that run.

Jon Johnson

Stock Splits & IH Alerts, Editor

InvestmentHouse.com