The bears on the market ramped up their rhetoric last Friday, when the University of Michigan Sentiment Index was reported to be much weaker than expected, at 63.2, when 69 was anticipated. This was followed by 4.3% drop in China’s stock market on the following Monday that was the biggest decline since last November. Other Asian equity markets, then the European markets and the U.S. stock markets followed suit to the downside. Falling commodity prices, along with talk of tighter lending standards at Chinese banks, contributed to the Global declines. Another negative factor, which was probably more psychological than anything else, was the news that Japan’s economy grew less than expected.  Japan‘s gross domestic product increased by 3.7%, on an annualized basis in the second quarter, which compared to the median guess a 3.9% advance.

There was some additional pressure when the weaker than anticipated U.S. housing data was released.  July housing starts, which are seasonally adjusted, were 581,000, which compares to an estimate of 599,000 and building permits were 560,000, when 577,000 were anticipated. This news added fuel to the fire for the bears, since most of the recent housing data had been coming better than the estimates. The bears were quick to point out that new home sales this year are running about 50% of what they were in 2007, while housing starts are only about 30% of what they were at their peak three years ago. In addition, they cited the fact that home prices have dropped about 15% this year from what they were last year.

The bears were not impressed by news that corporate earnings have been much better than expected in the past two quarters. In fact, one study showed that 72% of the companies in the S&P 500 reported earnings for the second quarter that were better than the analysts’ expectations. The bears maintained that the strong earnings numbers were only due to cost cutting and that revenues were generally less than expected. In addition, the bears continue to dismiss the bright spots that are beginning to emerge internationally. For example, the most recent gross domestic product data overseas is showing improvement. Germany, France and Japan are technically out of recession now. Keep in mind that the classic definition of a recession is two consecutive quarters of negative gross domestic product.

The bears are not only pointing to the fundamentals to support their point of view. There appear to be a majority of technicians that are bearish, as well.  One of the technical indicators that they are pinning their hopes on is the increase in the values for the VIX Volatility Index, which recently had its largest daily gain since last April. Some traders believe that the higher the Volatility Index the more likely the riskier assets, such as stock index futures, will soon come under selling pressure.  Their favorite bearish argument however, is the upcoming monthly seasonal tendencies. History has show that September is the worst performing month for U.S. equity markets. The bears are so confident in their outlook that many of them are saying things like “the only questions to be asked are how deep and how long the selloff will be?”
The chartists pointed to the breakout to the downside under the 98575 low in the September  S&P 500 futures as a confirmation of a new leg down in prices. However, that technical sign of weakness now appears to be a bear trap, since prices have recently moved substantially above that point.


 


One well-known fund manager went so far as to say that U.S. stock markets had topped out, while other  analysts were not quite as pessimistic when they said company valuations were far ahead of where the fundamentals are.

One common theme among the bears is their predictions of the possibility of a double dip recession. There appears to be a growing number of bears on this market, which makes us more comfortable with our bullish outlook.  Our analysis, which places considerable weight on the shape of the yield curve, continues to suggest that there will not be a double dip recession and instead, there will be a slow recovery that will gradually accelerate into next year.

The debate among us minority bulls is not if there will be a recovery. Instead, the debate centers around what the shape of the recovery will be? The most common viewpoint is that we will see a “U” shaped bottom, which suggests that there will be a slow turn in the economy before meaningful   growth returns. Some bulls are expecting a “V” shaped bottom, believing that a very quick recovery is likely and others say that the “W” bottom is most likely, meaning that another leg down is probable before an upturn. Although I am not going to be critical of my fellow bulls, I believe that the shape of the recovery (and for stock index futures) will not be a “U,” a “V,” or a “W.” My favorite letter, depicting the shape of recovery is the “J,” but with a slant to the right.  Our analysis continues to show that the worst of the Global economic downturn is behind us and that we can expect the majority of the economic and corporate earnings reports, for the balance of this year and well into next year, to be stronger than the consensus view. This, of course, will continue to support this new bull market in stock index futures. Continue to trade from the long side on weakness.

If you have any questions about this article or would like more information, please contact Alan at 1.800.243.2649 or email him at alan.bush@archerfinancials.com .

Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff.  The information provided is designed to assist in your analysis and evaluation of the futures and options markets.  However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc.