Waiting for GDP

With another listless trading day in the books, it’s becoming clear that investors are on hold for now and still awaiting some kind of market-moving piece of information.  Today’s durable goods report, while largely responsible for the slight selling pressure seen during the session, turned out to be a bit of a non-starter for the markets, which was a bit of a surprise.  (As an aside, I was fairly surprised to see such a disconnect between this report and the commentary we've seen out of corporate management of late.  In trying to reconcile this divergence, I reflected back on my comments regarding the China/Asia-focused nature of so many companies today.  By generating a larger proportion of the growth in companies' revenues and profits through the Chinese/Asian economy, slow downs in the U.S. economy's demand for durable goods are not as acutely felt as in years past.  While likely an oversimplification of the ultimate reasons for the disconnect, I have little doubt that this paradigm shift will at least cause many of the domestic macroeconomic indicators to diverge from the trends seen at the corporate level.  As such, we'll need to keep this in mind when trying to reconcile the relative strength/weakness of the U.S. economy and the impacts it will eventually have on earnings.)  Meanwhile, the Federal Reserve’s Beige Book commentary, as expected, merely reiterated the perspective offered during Chairman Bernanke’s Congressional testimony last week.  The report was cautiously positive in its tone, though peppered with concerns over the usual suspects: housing/real estate prices, job creation, and consumer spending.  Surprisingly, though, the equity markets took this ‘news’ as a reason to sell off in fairly dramatic fashion.  Here are the highlights:

1.    Opening Comments:  Economic activity has continued to increase, on balance, since the previous survey, although the Cleveland and Kansas City Districts reported that the level of economic activity generally held steady. Among those Districts reporting improvements in economic activity, a number of them noted that the increases were modest, and two Districts, Atlanta and Chicago, said that the pace of economic activity had slowed recently.

2.    Consumer Spending:  The outlook for sales was mixed: Retailers in the Philadelphia, Cleveland, Kansas City, and Dallas Districts reported that they expect modest positive sales growth in the upcoming months; contacts in the Cleveland, Atlanta, and Chicago Districts reported a less optimistic outlook going forward than in the previous report; and retailers in the Boston District reported a cautious outlook.
3.    Real Estate & Construction:  Nearly all Districts reported sluggish housing markets in the months since the homebuyer tax credit expired on April 30……Commercial and industrial real estate markets continued to struggle in all twelve Districts. Overall, vacancy rates were flat to slightly increased and continued to exert downward pressure on rents.

4.    Labor Markets, Wages, & Prices:  Labor market conditions improved gradually in several Districts…..Contacts in the Philadelphia, Atlanta, Dallas, and San Francisco Districts said that they continued to rely on temporary staff over permanent hires…..Wage pressures remained largely contained across most Districts…..Prices of final goods and services were relatively stable.

As you can see, there is little in this release that wasn’t already widely known.  As such, it’s hard to believe that today’s action was anything more than a bit of profit taking on the part of traders.  Light volumes continued, with 3.4 billion shares changing hands on the S&P 500, which likely added to the day’s volatility.

Interestingly, the Treasury market’s reaction to these reports was fairly muted throughout the day.  While yields finished lower across the curve, the bulk of the buying appears to have occurred after the equity markets closed, which is a bit of an interesting development.  In fact, this is the second time in the past week (last occurrence:  June 21st) that I have seen significant buy orders come into the Treasury market extremely late in the day.  In the original occurrence, this late day buying marked the near-term turning point in ten-year bond yields.  Perhaps this is a harbinger of some kind, but for now it’s nothing more than interesting development.  The five year note saw significant buying today as its yield dropped nearly 9 basis points to 1.7004%.  Thirty year bond yields, though, were virtually unchanged at 4.0725%, down about seven tenths of a basis point, which suggests that any deflationary concerns arising from the Fed’s comments are focused within the near term part of the yield curve rather than in the extended maturities.  So while there may have been some asset rotation today, it appears that it was minimal in scale.  As with equities, Treasuries are likely looking to Friday’s GDP report for clearer guidance on the domestic economy’s condition and will remain range bound until then.

One of the more interesting items I noted on the day (due in no small part to the fact that I have a position in it) was the out performance of the Dow Jones Transportation Index relative to the broader averages.  Despite the 0.69% decline in the S&P 500, the Transports finished the day nearly unchanged at 4,420.32, down just 0.07%.  This resiliency in the index suggests that the equity markets are pausing rather than reversing as strength in the Transports is normally a bullish leading indicator.  Had the Transports outperformed on the downside, this would be a much more concerning development.  And with volume declining 15% from yesterday’s levels, it’s difficult to conclude that today’s move lower showed any sort of increased pessimism among investors.  With that said, a sustained move above the 4,500 level on the Transports will be needed to confirm the viability of this rally.  Similarly, the S&P 500 needs a break through the 1,131 level to provide similar confirmation.  As you can see from the charts below, many markets are sitting at or near breakout/breakdown levels.  This suggests that markets are ripe to see increased volatility sooner rather than later.  For now, my read is that this volatility spike will favor the bulls over the bears.

With the always market-moving GDP report looming on Friday, I wouldn’t be surprised to see most markets continue the anemic trade through tomorrow’s session.  Initial jobless claims will be worth watching, but barring any sort of blowout number in the report, traders will largely look past the data.  With so many of the markets currently perched at levels that suggest prices could move sharply in one direction or another, the importance of Friday’s GDP reading appears to be growing.  And aside from the initial look into GDP performance in Q2, many (myself included) will be looking to see what, if any, adjustments are made to the Q1 numbers as well.  Taken together, these two data points should go a long way towards shedding some light on where the economy is ripe to go.  And if this morning’s durable goods report is any indication, the outlook could be challenging.  However, to an extent, the actual numbers are inconsequential.  Ultimately, it’s the opinion of market participants that matter as these are the collective opinions that will drive prices higher or lower.  For now, I believe the bulls will win out.  But given my larger bearish outlook for the economy and the markets at large, timing my exit if/when this rally materializes will be key.  And when this time comes, rest assured you’ll be the first ones to know.  Until tomorrow…..