S&P 500 & Nasdaq Analysis and Trends

[frenchee]

End of the Soft Patch?
September 16, 2004


The market is continuing its eight-month old pattern of lower highs and lower lows while any incipient signs of an ending to the “soft patch” require a microscope in order to be seen. Following the March high of 1163 in the S&P 500, two rallies failed to change the downward sloping trend, and now the third one may be on the verge of doing the same. The first rally ended in early April with a gain of 5.5%, and the second one in late June with a rise of 6.5%. The current rally showed an increase of 6.4% at yesterday’s intra-day top, and is showing signs of being overbought while volume has remained tepid and sentiment overly bullish. In addition the market has also factored in the correction in oil prices, and the Bush post-convention jump, as well as overly optimistic expectations for the economy and earnings.



Some observers have professed to detect an ending of the economic soft patch and resumption of growth, although it seems to us that they are basing their assumptions on some relatively minor up-ticks in secondary indicators. Meanwhile the real economy seems to be treading water without the impetus of tax cuts, massive mortgage refinancing and an unusually easy Fed. Chain store sales remain sluggish while General Motors and Ford are engaged in significant production cuts. Employment is still weak as it has been for all but three of the last 33 months, and wages continue stagnate. Major technology companies consistently report disappointing sales and rising inventories as back-to-school computer sales have been disappointing and corporations see little reason to spend on IT despite strong cash flow and robust liquidity. Today’s breakdown of long-term bond yields to new lows for this move may indicate that the bond market is already anticipating a continuation or further deterioration of the soft patch.



All of this is happening at a time when consumer savings rates are low, household debt at an all-time high relative to GDP, the trade balance at dangerous levels, and stocks still excessively valued. At the same time the Fed is highly likely to raise rates another quarter of a percent next week, not so much to slow down an already sluggish economy, but to create a cushion that enables them to lower rates later. In sum, it appears to us that the market has already discounted a rosy scenario that is unlikely to occur while ignoring some major factors that can derail stocks in the period ahead.