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Global Outlook

Crossing Wall Street: Market Review

June 6, 2014, Friday, 20:08 GMT | 15:08 EST | 23:38 IST | 02:08 SGT
Contributed by eResearch

This has been a remarkably efficient stock market. I say that because it is effortlessly made fools of everyone.

Remember all that talk about "a bubble" and that we're "due for a correction"? Well, apparently Mr. Market wasn't cc'd on that. On Thursday, the S&P 500 rallied for the 14th time in the last 19 sessions. The index hit yet another all-time high. (I was particularly impressed when it blew past the historically significant 1,929 marker.)

As we look at this rally, we have to keep in mind all the negative news that could have tripped us up -- like the lousy Q1 GDP report, or the ongoing tensions in Ukraine. None of that seems to matter. Everyone, it seemed, was expecting a mass rotation out of bonds. Didn't happen. Instead, bond yields have plummeted this year.

Despite the market's resiliency, what's truly been remarkable is how little trading volume there's been. In less-technical terms, where the heck did everybody go? Trading volume has plunged, and the bull just doesn't care. In this week's CWS Market Review, we'll take a look at what this low-volume, low-volatility rally means. I'll also highlight some of the recent economic news. But first, let's look at where the economy stands.

Finally, an All-Time High for Jobs

On the first business day of each month, the Institute for Supply Management releases its Manufacturing Index. I like to keep a close eye on the ISM report for a few reasons. One is that it comes out so quickly. A lot of economic reports come weeks after the fact. It is also one of the econ reports that is not endlessly revised.

The ISM also has a good track record of lining up with recessions and expansions. Here is how it works: Any number above 50 means that the manufacturing sector is expanding, while readings below 50 mean it is contracting. When the index is below 45, it usually corresponds to a recession. The ISM Index has been 49.0 or better for the last 59 months in a row, which lines up exactly with the current expansion.

On Monday, ISM had some problems. They had to revise their May report not once, but twice. It is embarrassing, but they finally settled on a figure of 55.4, which was only 0.1 below what Wall Street had been expecting. That is a decent number, and it suggests that the manufacturing sector is still healthy. For now, I do not believe there is a risk of an imminent recession.

On Monday, we also learned that construction spending rose by 0.2% in April. Frankly, that was a bit weak. Economists had been expecting an increase of 0.7%. Also on Monday, we learned that housing inventory is up 10.5% from a year ago. This is very important, since there was so much overbuilding during the expansion. All that excess inventory had to be burned off. Inventory is still quite low, and prices have been rising. Housing is not the biggest part of the economy, but it is probably the biggest part in determining the direction of the economy.

Then on Tuesday, the carmakers reported good sales for the month of May. Sales for GM rose 13%, and sales for Chrysler rose 17%. Sales at Ford rose only 3%, but that is actually a decent performance. Ford has been cutting back on its incentives in an attempt to manage its inventory. This was the best May for Ford in ten years. On Thursday, shares of Ford got as high as $16.89, which is a six-month high. I like this stock a lot. Ford remains a solid buy up to $18 per share.

Now about the jobs report. As usual, I am writing this newsletter to you early on Friday morning, and the big jobs report will come out later this morning. In fact, it is probably out by the time you are reading this (check the blog for updates).

It is always a hazard guessing how many new jobs were created. The government is very clear that its estimates have a very wide error range (the standard deviation has been 236,000), but that does not stop Wall Street from playing the guessing game. What is more important to me, however, is the general trend of new jobs. Fortunately, that is been rather good lately. Of course, there are still lots of unemployed folks out there, especially longterm unemployed.

On Wednesday, ADP, the private-payroll folks, said that 179,000 private-sector jobs were created last month. That was below expectations, but I should caution you that ADP does not have a great track record as a bellwether for the government's report. On Thursday, the Labor Department said that unemployment claims rose to 312,000 last week. That is a good number. Since this number bounces around a lot, economists like to focus on the four-week moving average, which is now at a seven-year low.

It is very likely that Friday's jobs report will show that we finally surpassed the peak employment set in January 2008. In other words, it is taken us six and a half years to create a few thousand jobs. As rough as that sounds, the economy lost 8.7 million jobs in 25 months. It then took another 51 months, more than twice as long, to make them all back. Wall Street has high expectations for this report. The current consensus is for 213,000 jobs. The economy added 288,000 jobs in April.

Also on Thursday, the Federal Reserve released the big "Flow of Funds" report. This is always an interesting report to see. According to the Fed, U.S. household net worth rose to $81.8 trillion at the end of Q1. In the last five years, our net wealth has risen by more than $26 trillion.

Overall, the broad economy appears to be doing well. More folks on the Street expect GDP for Q2 to be over 3%. It could be as high as 4%. One of the better economist reports is the Fed's Beige Book. It is a bit on the wonky side, but it has some good tidbits. The most recent Beige Book reported growth in all 12 of the Fed's regions.

Another one of my favorite economic indicators is the yield spread between the two- and ten-year Treasuries. While the 10-year has rallied this year, it still yields 219 basis points more than the two-year. That is a big gap.

Whenever that spread turns negative, you can be sure the economy will soon hit a rough patch. The 2-10 spread has a much better track record than a lot of highly paid folks on Wall Street. The 2-10 has been over 200 basis points every day for nearly a year.

Hey, Where Did Everybody Go?

On Thursday, the S&P 500 closed at 1,940.46, which is another all-time high. But what is interesting is that the market has rallied on very low volatility and low volume. The trading volume has declined remarkably. On Wednesday, trading in the S&P 500 ETF (SPY) hit a new low for the year.

Last month, an average of 1.8 billion shares were traded in the S&P 500 companies. That is the lowest volume in six years. During May, an average of $26 billion was traded each day in S&P 500 companies. That is down from $32 billion in April.

Also, the market's breadth continues to narrow. On May 23, the S&P 500 made a new high, but only 24 stocks in the index made a new 52-week high. I will warn you that these are traditionally negative signs; the problem is that you never know when the trouble will begin.

Earlier this week, the Volatility Index (VIX) dropped down to 11.29, which is the lowest level in more than a year. (Warning: math stuff ahead.)

If you have ever wondered what the VIX is, it is the market's estimate of the S&P 500's standard deviation over the next month. The hitch is that it is expressed in annualized terms. To turn into a monthly figure, just divide the VIX by the square root of 12, which is 3.46.

So, the current VIX of 11.68 means that traders think the S&P 500 will move up or down by 3.37%, or about 65 points, over the coming month.

Only two years ago, the European bond market was ready to sink into the Adriatic. Now bond yields in the Old World are at their lowest point since the Battle of Waterloo. Mario Draghi just dropped the deposit rate from 0% to -0.1%. The European Central Bank is now the first major central bank in the world to go to negative interest rates. So much of the European economy is still in shambles. In 1914, Lord Grey famously said, "the lamps are going out all over Europe." This time, it is not a metaphor. it is not a metaphor.

On this side of the pond, the market still seems reasonably priced despite the rally. Analysts on Wall Street currently expect earnings this year for the S&P 500 of $119.82. The estimate for next year is $137.38, but that is probably too high. As long as yields stay low, the spreads are wide, and the economy is generating more than 150,000 new jobs each month, then the bull case is intact.