Stocks Become Overbought

Ask yourself the following question: What is the worst macroeconomic environment for stock market investors? Yep, that’s right; an economy that is growing, but just barely, with little job creation and just enough inflation to keep the pain up. In short, this environment amounts to what has been termed a “grocession,” where the economy isn’t technically in a recession but really isn’t growing either. And then when you toss in a dash of inflation (you know, just enough to keep the inflation hawks on the Fed nervous), you’ve got a recipe for weak stock returns.

After moving up about +8.5% in just seven days, it is safe to say that stocks had become overbought this week. And as such, a little pullback was certainly to be expected. But what was so very interesting about Thursday’s session was the fact that the market received what appeared to be good news and yet the bulls couldn’t do anything with it.

When the all-important ISM Manufacturing Index was released at 10:00 am eastern yesterday morning, my response was, “Wow! That’s MUCH better than expectations.” You see, the consensus forecast for the ISM number had been 49.1, which, most importantly, would have signaled that the manufacturing sector was entering a contraction phase. And given the extremely weak regional PMI’s that we’d been treated to recently, our estimate was in the mid-48′s while the “whisper number” was down around 45.5. So, when the number came in at 50.6, well, it was quite a surprise.

The good news from the ISM index was three-fold. First, the number wasn’t the disaster many had expected. Second, the index came in above expectations. And third, the level was still above the all-important 50 line-in-the-sand. All good, right?

The market’s initial reaction was about as expected. The Dow surged higher and gained more than 130 points in about two minutes. For those who were on the short side, the likely reaction was something along the lines of, “Oh no, here we go again.” But a funny thing happened to the celebration for this much-better-than anticipated number – the party was quickly cancelled and from 10:04 am onward, stocks sold off.

The problem here – and the reason for the selling – was fairly simple. Stocks had been rallying hard over the past week and a half on the idea that the Bernanke cavalry was about to ride to the rescue again. The issue of whether the Fed’s plan would actually work was of little regard. The bottom line is more bond buying and lower interest rates are good for the hedgie types.

However, exactly four minutes after the ISM Manufacturing Index was released, it was like a light bulb went on at the corner of Broad and Wall. Collectively, traders appeared to say, “Uh oh, this isn’t good.” The key is that slow growth doesn’t equate to new stimulus by the Fed this month. No, this news may not have been bad enough for traders to bet on another batch of Bernanke bucks being passed around.

However, we’ve got another shot at another very important number this morning. So let’s dispense with analysis of yesterday’s news and get to the August Jobs report.

Turning to this morning… Worries about Greece have returned as reports indicate that the Greek government will miss its 2011 budget deficit target by a wide margin and is unwilling to make additional cuts. In addition rates for Italian and Spanish bonds continue to rise (Italian yields have risen 10 days in a row). European bourses are down hard and U.S. futures are pointing to a lower open in front of the jobs report.

On the Economic front… The Labor Department reported that Nonfarm Payrolls were unchanged in the month of August. This was well below the consensus estimates for an increase of 71,000 and July’s revised total of 85K (revised downward from 117K). The May and June totals were revised lower by a total of -58K. The private sector (aka the household survey) showed gains of 17K jobs, which was also below the estimates. The nation’s Unemployment Rate held steady at 9.1%, which was in line with the expectations for a reading of 9.1%.

Stock futures have moved to the lows of the session on the news.

David Moenning
Editor:  The Daily Decision