After a six-month, virtually uninterrupted advance of around the 50% magnitude, stock index futures have come under some pressure in the last few days. The bears have become more vocal in their thinking that range from the view that we are in for a severe correction to the more extreme idea that the March lows will be taken out. There is substantially more talk that there will be a double dip recession when the effects of the various government stimulus plans diminish or are withdrawn.

Worries remain that there will be a slowdown in the rate of bank lending in China, which could adversely affect the U.S. equity markets, especially after China’s Shanghai Composite Index fell 6.7% in a single day recently. This buoyed the arguments of the bears, since this was the largest decline since last June. The 20% decline from the highs was “confirmation” for the bears that a new downtrend had begun for China’s stock market.
There are reports that mutual funds and pensions are selling U.S. consumer stocks at the quickest rate in 14 years as they continue to cite a “tired consumer.” In addition, some of the bears on this market believe that the relatively high current price to earnings ratio of 19 for S&P 500 companies is a reason to expect lower prices for futures. Even though this is the highest price to earnings ratio since 2004, our analysis suggests that increases in earnings later this year and next year will justify the current PE ratios.  

In addition, U.S. on balance shares sold by corporate officials increased in August to their highest level since the second quarter of last year.

Also, much of the media is talking about how the month of September is historically the weakest month of the year for U.S. equity prices. The record shows that this statement is correct. There is plenty of speculation that the market’s performance this September will be a repeat of last September’s downdraft, which was one of the weakest months of last year’s trade. There is one thing to keep in mind, however. Seasonal tendencies are not the best indicators of future price movements. Let’s take a look at some of the seasonals that came into play over the past few years that failed miserably. For example, the third and fourth years of a presidential term are thought to be bullish, based on ideas that steps will be taken by the administration to improve the economic outlook and the mood of voters in advance of a presidential election.  Those seasonals did not work.   In addition, it should be no surprise that in the first year of a presidential term, stock index futures, historically, tend to underperform. This is because some of the “giveaways” that took place before the presidential election are taken back in the first year of a president’s new term.

The bears appear to have gained the momentum, at least for now, allowing for some very bullish economic statistics to be ignored. For example, the August Institute for Supply Management (ISM) Manufacturing Index was expected to increase to 50.5. In fact, it came in much better at 52.9, which was the first increase since January of 2008. This caused some analysts to increase their gross domestic product estimates for the third quarter to as high as up from between 4% to 6%.  

Even though corporate earnings season is over, it should not be forgotten that corporate earnings were much better than anticipated. 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 were not impressed and 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, it was reported that German consumer confidence increased to its highest level in almost a year and a half.    It was also reported that U.K. home prices increased at the fastest rate in over two and a half years, according to the Nationwide Building Society. In addition, there was an Australian government report that showed economic growth unexpectedly increased in the second quarter by .6%.  The median guess for the report was up .2%.

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?” Many technicians have become more bearish based on the penetration of the 101325 uptrend line on the September S&P 500 daily chart.   Our belief is that this technical sign of weakness will prove to be another “bear trap,” as was the mid August drop to the 97550 level.  

September S&P 500 Futures – Daily
 
Chart Provided By APEX

Although the above daily chart clearly shows a trend line penetration to the downside, there are no such similar technical signs of weakness on either the weekly or the monthly charts. In fact, the weekly and monthly charts continue to show the uptrend is intact.    
                                 
S&P 500 Futures – Weekly
 
Chart Provided By APEX

S&P 500 Futures – Monthly
 
Chart Provided by APEX

Our analysis continues to suggest that all of the bearish arguments cited will not take this market lower.  In fact, the growing number of bears makes us more comfortable with our bullish outlook. Our latest research suggests that the recent weakness in futures will prove to be another “bear trap,” causing shorts to cover their positions later at higher prices.  

There is one main indicator that we believe is more important than all of the indicators that the bears on this market have used to advance their cause. Our research places considerable weight on the shape of the YIELD CURVE, which is positive and continues to suggest that the worst of the global economic downturn is behind us and that there will be an economic recovery that will gradually accelerate into next year. There will not be a double dip recession. 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 will continue to support this newly emerging bull market in stock index futures, which we believe is in the early stages of a multiyear bull market. Continue to trade stock index futures from the long side on weakness.

If you have any questions or comments on this article, 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.