On Thursday, markets gave back gains accumulated on Wednesday, attributed to the Fed’s easy money stance through to 2014. Investors are starting to show signs of profit taking after equity benchmarks have become the most overbought since last May’s peak and sentiment indicators are indicating excessive bullishness in the market. Market participant are beginning to question the recent strength amidst the lackluster earnings season, concerns of default in Greece, and the Fed essentially indicating economic struggles for years to come. To date, just over half (55%) of corporate earnings have beat estimates, which have been ratcheted down in recent months due to economic concerns. This is well off of the beat rate of around 70% witnessed in recent quarters, signaling that this is the most disappointing earnings season since the economic recovery began in 2009. Couple that with the extreme overbought conditions that are indicative with a market peak, a correction appears justified. Still one possible positive catalyst remains: the Fourth Quarter GDP report to be issued on Friday. Expectations are optimistic and reaction to the number amongst equity markets is pretty much guaranteed.
The S&P 500, gave back all of the gains from Wednesday, marking somewhat of a reversal. The level to hold is1300; a level that if broken would likely bring in more selling pressure. Downside risks remain to significant moving averages, such as the 50 and 200-day, which continue to be approximately 60-points lower than present levels. Recent leadership from the financial sector appears to have ended, underperforming the market for a second day following the Fed’s announcement. Yet, the 50 and 200-day moving average look set to complete a bullish cross pattern, signifying improving intermediate-term prospects. At this point a shallow correction is anticipated and the extent of the significance of the peak, which presumably will form below the May and July peaks above 1350, will have to be analyzed to determine if the lower significant high means a longer-term downtrend.
The pending pullback in the short-term may actually be triggered by the Fed’s accommodative monetary stance. Recent weeks have show bond market participation in the equity market rally as assets flowed from bonds into equities. With the fed’s commitment to keep rates low, investors have flocked back into bonds to take advantage of the near term rise in prices. What will be key is if yields can hold above recent lows, at approximately 1.8% on the 10-year, as it would signal that commitment to equities remains and that a new bond market rally has not started. Participation from the bond market will be key in order to keep the buying momentum in equities strong.
Another important factor in order to determine the strength in equity markets is the strength in copper as I mentioned in earlier emails. Investors call it Dr. Copper due to its predicative qualities of market direction. On Thursday Copper broke through a level of resistance indicated by its 200-day moving average. The metal has been outperforming equity markets throughout January as seasonal tendencies lift the commodity. Given the low interest rate environment, commodities look poised to outperform the market, as is seasonally typical, through to May. A number of metal commodities are still significantly overbought, signaling that even commodities are prone to a correction at this point before moving higher which would correlate nicely with equities trading near resistance hence the pullback to come.
