U.S. stocks closed out a very nice week on a high note, with most of Friday’s rally occurring late in the session, again – 85% of the day’s gain occurred in the final 90 minutes.  The market didn’t have much data to trade on, just an inventory report that wasn’t all that positive to begin with.  It appears the ebb and flow of global economic weakness continues, and it ebbed last week.

It was the best week for stocks in a year, up 5.42%, but of course it followed a 5.03% decline in the previous week. So we recouped the prior week’s losses, but the downtrend of late reduces the excitement one can have over such a good week of performance.  Now that we’re back to 1077 on the S&P 500, the new level of resistance technicians are talking about is 1085.

Basic material shares led last week’s rally, but the shares are putting pressure on futures this morning after China’s iron ore and copper imports reportedly fell last month, the third-straight month of decline. 

The ebb and flow regarding European sovereign debt and banking concerns is on the flow again.  Euribor, the interbank offer rate, continues to climb and that’s not going to help the lack of economic activity in Euroland.  If this rate continues to rise, banks become even more concerned about what the other guy owns and the unwillingness to lend to one another increases, the ECB (euro zone’s central bank) will have to keep playing its unprecedented role. 

In other news, BP and the Coast Guard stated on Friday that they may contain the GofM gusher by accelerating the installation of a tight seal.  We’ve heard this kind of thing before, but if they get it done this time, the market should rally on the news – at least temporarily, unless some of last week’s rally was in anticipation of a successful cap.

Market Activity for July 9, 2010

Wholesale Inventories

Distributors’ inventories rose 0.5% in May, marking the fifth month of increase and the seventh out of the last eight.  The prior month’s reading was revised lower to show a 0.2% increase, estimated at 0.4% last month.   

The vital sales data fell for the first time since March 2009.  One month does not a trend make, but this is something to watch.  As you all know, my feel is that factory and overall economic weakness will become conspicuous by September; this could be suggesting the slowing, but it will have to be confirmed by June’s reading.

The inventory-to-sales ratio ticked up to 1.14 month worth, off of the record low of 1.13 in April.  Since levels remains so tight, firms have the room to continue boosting stockpiles, but they’ll need the sales growth to compel them to do so.  There’s a reason inventory levels remain so low, firms are not confident about the future.

We’ll get the business inventories reading on Wednesday, which includes retail sector data and thus offers a broader look at the inventory situation.  

Central Bank Actions

We’ve spent some time talking about the likelihood the Fed will engage in a new round of QE (quantitative easing, which mostly means an unconventional way of pumping money into the system by buying mortgage-backed and longer-term Treasury securities, an action which also either drives rates lower or holds them low).  They haven’t announced this of course, but my view is that the economic realities, largely the debt financing challenges of the federal government and a housing market that is entering another round of nasty, will make them believe they need to do so.  Surely, Bernanke’s paranoia about deflation will also end up driving his decision to do the next big bang QE round – all one needs to do is read his 2002 speech Deflation: Making Sure “It” Doesn’t Happen Here, specifically the final paragraph. 

Going in the other direction, or at least talking it, the ECB has recently suggested they’ll either complete their government-bond purchase program or pare it back.  ECB President Trichet stated on Friday that European financial market troubles are beginning to ease.  I’ve heard this one before, and as discussed above interbank lending rates don’t jibe with this assessment. 

Whether it has been the constant ebb and flow of the European debt concerns (one week all is clear, the next two weeks the market worries that the problems remain – I’ve got to say, it’s complete nonsense to belief the problems have eased, it will take tough structural changes to make things right over there, which is probably going to take a couple of years) or our own issues here at home (and it’s not just federal but state and municipal budget woes will become more acute over the next year), credit and debt issues in the Western world will reverberate throughout the globe for a while still.

Expect to see the ECB boost their debt purchases again, and here in the U.S. QE version 2 will probably become reality by early 2011.  As the consensus begins to price this in it may juice equity markets.  But the market will eventually be reminded, once again, that all is not clear.  Domestic and global growth is weak relative to prior economic recoveries, even with unprecedented levels of stimulus.  There’s a reason for this and it will tug on stocks for some time.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900