Stocks moved up to a key resistance level last week, with the S&P500 closing at 4,299. There are several unique and troubling aspects about this current recovery. It appears to me stocks are more likely to go down than move higher.
The Week That Was
Last week’s economic numbers sent conflicting messages. The May ISM survey for service companies shows a significant slowing from prior months, with readings close to break-even. In contrast, the S&P service industry survey shows the strongest level year-over-year.
The week’s employment numbers were equally indecisive. There was a jump in initial unemployment claims for the week ending June 3. However, both the four-week average of claims and raw unadjusted data show no significant change from a year ago.
Things to Come
Tuesday’s CPI report will be a key factor in the Fed’s decision this Wednesday on whether to continue increasing interest rates. The consensus estimates are for the core CPI to be up 0.4 percent and for the total to be up 0.3 percent.
The May business surveys show some moderation in inflation increases in the service sector and price declines in manufacturing. Both inflation measures will benefit from the 8 percent decline in oil prices.
Wednesday’s Fed meeting will be the highlight of the week. The odds are 70 percent in favor of a pause in inrterest rate hikes, particularly if inflation comes in below expectations. If inflation is moderately higher, the Fed may decide to pause and indicate it expects to raise rates this summer if inflation remains high.
Thursday we’ll get government reports on May retail sales, which have shown no increase for the six months ending in March, and only a 2 percent increase the past year.
With incomes and wages rising 5 percent for the past year, there is a lot room for retail sales to move higher. The consensus expects little change in sales, but we expect a strong increase of 1 percent or at least some upward revisions to prior numbers.
Money, Money, Money
The fed funds interest rate is up to 5 percent from 3 percent in October, while the amount of money in the economy in early June is 17 percent less than a year ago.
The problem with money is that even with a 17 percent decline, it remains 20 percent above where it was two years ago. This highly erratic pattern plays havoc with businesses by giving dramatically mixed signals over the strength of the economy.
Another irony is the behavior of longer-term interest rates. The 10-year T-note peaked at 4 percent in October and is currently 3.7 percent. The rise in shorter-term interest rates above longer-term rates is a clear signal of monetary restraint.
Financial markets remain convinced the Fed’s policy will weaken the economy while helping to contain inflation. We agree. However, the surplus in money over the past two
years can sustain both the economy and inflation longer than financial markets expect.
Unless this week’s upcoming CPI is unusually high, the Fed will pause before considering additional restraint.
Market Forces
Stocks were higher this week. The S&P500 moved to a key resistance level of 4,300, which was the peak reached last summer before the collapse to 3,600. Since then, the index is up 20 percent.
There are several unique and troubling aspects about this current recovery. Trading volume is flat to down while psychological indicators are very bullish. Both are bad news for stocks.
Most unusual is the fact the rebound has occurred during a period of monetary restraint. Stock prices are at a key technical resistance level. A downward move from current level is more likely than not.
Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 13 percent
Monetary Policy: restrictive
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