Honestly, I thought today’s equity market rally would have come yesterday. After the dramatic selling that was seen last week, it made sense to me that a weekend respite from trading would allow enough optimism to seep back in to the marketplace and entice some solid Monday bids. And while yesterday’s price action was resilient, the fact that everything stayed flat really concerned me and suggested that more selling could be in offing. However, thanks in part to the market’s oversold condition as well as a stronger than expected inflation reading (Producer Price Index), the bulls spent the day in control of the price action. For the day, the S&P 500 finished up 13.16 (1.22%) to close at 1,092.54. To be sure, this move higher can’t be counted as anything more than a relief rally at this point, especially given the weakness that was seen near the close (the S&Ps lost near 7 points in the final 30 minutes of the session). More than anything, this is further verification that we are still mired in the whipsaw, range-bound trading environment that has characterized the summer of 2010. With volume registering only 3.4 billion shares on the S&P 500, there simply isn’t broad enough participation for the market to move with any real conviction. But as I’ve been saying for the past month, the real concern for investors is when volume does return since volatility is likely to shoot through the roof. Being on the right side of that volatility will be critical. For my part, I still view downside equity price risk as the most likely outcome during Q3 and Q4 of 2010 and, therefore, will be inclined to play things from the safety of cash. Perhaps a short will be warranted at some point, but I’ll have to play that by ear.
As I mentioned last night, I’m of the opinion that the rising concerns about deflation are causing many investors to flee to the safety of Treasury bonds. And while I agree that the prospects for a deflationary cycle are certainly viable, I haven’t been able to reconcile the dramatic drop in Treasury rates that were seen yesterday. Today’s trading in Treasuries saw selling across the curve, but not nearly of the scale as that of yesterday’s buying. This would suggest, of course, that these deflationary concerns, along with the beginning of the Federal Reserve’s Treasury note purchase actions, are continuing to support the marketplace. Interestingly, though, this morning’s Producer Price Index’s seasonally adjusted inflation reading of 0.2% during the month of July did little to stem these concerns. Stripping out food and energy costs (so called ‘core’ PPI), inflation marched forward 0.3%. These readings, while certainly far from inflationary, break a string of three consecutive months where PPI prices had declined anywhere from 0.1% to 0.5%. While I’m not trying to imply that this one report spells the end of the deflationary threat in the U.S. economy, I think it’s worth noting that inflation is still occurring. In fact, when looking at the PPI data in its unadjusted form, year over year inflation stands at 4.2%. That’s a far cry from the -6.9% year over year rate that was seen in July of last year. So with this data in mind, I can’t help but worry that the recent spike in Treasury prices is a bit overdone, at least for now. Deflation does remain a threat, though, especially when considering the looming challenges the economy faces during the rest of the year (expiring tax cuts, uncertain regulatory environment, waning fiscal stimulus). However, let’s take a step back and put the data in its proper context. Inflation is present, but it’s also extremely low. Therefore, Treasury ownership (or outright cash positions) is warranted as a hedge against deflation. That said, I would rather be a buyer on weakness rather than get caught up in the buying frenzy. Especially since the inflation/deflation debate is still largely undecided.
Seemingly as supplement to the PPI numbers, the Federal Reserve’s estimate of the nation’s utilization of its productive capacity rose slightly during July to a reading of 74.8. This was an increase from June’s reading of 74.1 and July 2009’s reading of 69.1. In short, this implies that domestic production is picking up. To be sure, this is but one data point among many, but, again, it’s clear that the U.S. economy is at least stabilizing. Whether or not this stabilization becomes the norm (i.e., the Japanese economy of the last 20 years) or portends coming economic growth remains to be seen. Until our country’s productive capacity begins to return to relatively high levels of capacity utilization (85% and above), the prospects for additional corporate capital investment and accelerating economic growth remain challenging. As such, this is a number that will be worth watching rather closely.
With virtually no economic data on the calendar for tomorrow, the price action across all markets will be interesting to watch. I suspect that this will end up being a decent barometer of investor sentiment as trading will be largely dependent upon earnings and the whims of market participants. My sense is that sentiment may be turning back to the bullish side of the coin ever so slightly. We’ll see if tomorrow’s trading does anything to change this opinion. Other than that, I’ll be looking to Deere & Co.’s earnings release tomorrow with particular interest. In light of the spike in nearly all agricultural commodity prices, I would expect management to present a fairly robust outlook for coming quarters as U.S. farming profits will likely be up by year’s end. The company’s expanding global presence should also provide additional insight on the health of the global economy. That said, it’ll take more than a positive earnings release from a tractor company to break this equity market out of its range. I still have no idea what the catalyst will be that moves this market out of its funk, but I’m looking for it to show up some time in early September. It could be that a pickup in volume is all this market needs to breakout, but we’ll see soon enough. Until tomorrow…..
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