Courtesy of John Nyaradi.
Storm clouds gather over U.S. and global stock markets
As the First Quarter draws to a close, storm clouds gather on both fundamental and technical levels as we look ahead to the Second Quarter. Earnings reports, economic reports, seasonal factors and technical indicators cast a long shadow over the outlook going forward.
On My Wall Street Radar
chart courtesy of StockCharts.com
In the chart above of the S&P 500 (NYSEARCA:SPY) we can see that the point and figure methodology has issued an alert, “long tail up,” which indicates overbought markets and the likelihood of a correction ahead. You can see how the long column of Xs has climbed without interruption, and a pullback/correction to the 1300 level would not be unexpected within the context of an ongoing bull market.
Other technical factors at play include continuing overbought conditions, declining breadth and advance/decline lines and declining momentum as the major indexes stall at long term resistance. Divergences like this oftentimes lead to measurable declines and we expect sideways to lower prices ahead over the short to medium term.
The Dow Jones Industrial Average (NYSEARCA:DIA) is drifting back towards the psychologically important support level of 13,000 and short term momentum has turned negative.
The Nasdaq 100 (NYSEARCA:QQQ) remains in nosebleed overbought territory with an RSI reading of 74, declining momentum and stochastic on a “sell” signal from overbought levels.
The Russell 2000 (NYSEARCA:IWM) has declined to significant support after failing at near term resistance.
The all important financial sector (NYSEARCA:XLF) has been a market out performer year to date and now also finds itself overbought and with declining momentum heading into the end of the first quarter.
The Economic View From 35,000 Feet
Fundamental factors also point to storm clouds ahead as earning season is about to start and early indications are less than stellar.
FactSheet.com reports that earnings growth rate is set to decline for 1Q, the first such decline since Q3, 2009, with seven of ten sectors pointing south, while profit warnings run 3:1 ahead of positive forecasts. Furthermore, without Apple’s earnings included in the mix, S&P 500 earnings growth would show a decline of 1.6%.
Furthermore, Europe is entering a recession, China is in a major economic slowdown, along with the rest of the emerging world, and with approximately 50% of S&P 500 earnings coming from overseas, we can expect increasing headwinds for earnings heading into Q2.
Seasonality will also start to come into play as the well established and widely watched “sell in May and go away,” factor is on the horizon, the period from May to October when the stock market tends to deliver sub-standard or negative returns.
The economic news last week favored the negative side of the ledger as the positive side saw jobless claims fell to their lowest levels in four years, the Greek crisis abated with the successful resolution of its credit default swaps payout and leading indicators rose to beat expectations.
On the negative side, a European recession is a near certainty as the IMF forecasts GDP contraction of -0.2% for the region and China is making a marked slowdown with its PMI dropping into contraction territory. French and German manufacturing contracted and U.S housing starts and home sales for February fell and missed analysts’ expectations while gasoline prices continued to rise.
Next week brings a stream of economic data including consumer confidence, durable goods, weekly unemployment. Thursday is a big day with the Q4 GDP estimate and Friday brings consumer spending, sentiment and Chicago PMI which will be widely watched and compared to recent news from Europe and China. We’ll also see the start of earnings season with reports from Lennar in the home building sector, and Best Buy in the all important retail sector.
What It All Means for Stock and ETF Investors
What it all means is that a global economic slowdown seems to be forming while technical indicators continue flashing red. Offsets to the negatives are the ongoing support efforts from the Federal Reserve and European Central Banks. However, major forces like seasonality and overbought conditions, along with declining earnings tilt the risk/reward balance towards increasing risk and declining rewards over the short to intermediate term.
Disclaimer: Wall Street Sector Selector actively trades a wide range of exchange traded funds (ETFs) and positions can change at any time.
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