Why do stock index futures continue to advance in spite of so much negative sentiment surrounding the economy and the equity market outlook? In fact, many of the recent comments on the economy have been focusing on the extremely negative side. One economist said the economy is facing a death buy a thousand cuts and another said advances in stock index futures cannot carry on at the current rate because there are barriers to what is reasonable. Many others remain negative on the economy, but are a little more kind when they say that there will be a double dip recession in the economy when the effects of the various government stimulus plans diminish or are withdrawn. However, they don’t want anyone to bullishly misconstrue this tepid, at best, economic outlook by referring to their “W” bottom prediction for the economy as only a lower case “w” recovery. Apparently the lower case “w” bottom that they refer to describes their expectations of the possibility of two minimal recoveries.

With all of this negative sentiment on the economic and stock index futures outlooks, there is one main question that must be asked. Why does all of this seemingly expanding negative commentary exist in spite of the six month, virtually uninterrupted advance in stock index futures prices?  The broad indexes are approaching 50% or higher recovery levels since the March lows were registered.  In fact, the higher the indexes go the more vocal the bears have become.   Their thinking runs the entire gamut with the most extreme view being predictions that the March lows for stock index futures will be taken out.

CHINESE STOCKS FALSE SELL SIGNAL

There were worries that there will be a slowdown in the rate of bank lending in China, which could adversely affect the U.S. equity markets. This theory was advanced heavily by the media when after China’s Shanghai Composite Index recently fell 6.7% in a single day. This buoyed the arguments of the bears, since this was the largest decline since June 2008. The technicians quickly jumped on board, as well. They cited the 20% decline from the highs as “confirmation” that a new downtrend had begun for China’s stock market and the U.S. equity markets would have to follow.  However, countering this argument was the subsequent advance in China’s stock market, which was the largest increase in the Chinese stock market in six months.  This 4.8% advance in the Shanghai Composite Index took place after the vice chairman of the China Securities Regulatory Commission said China will support a “stable and healthy” market. This reduced fears that the Chinese government was increasing measures to limit stock and property speculation. There were further gains in Chinese stocks after China reported that factory output increased by 12.3% from a year ago. The median guess was an 11.8% advance. More recently, the Shanghai Composite Index advanced 2.2% to its highest level since August 24th. This, in turn, helped global equity markets to advance, as well. The rule to be learned here is that it is probably not a good idea to sell U.S. stock index futures solely based on what China’s stock market is doing.

FADE THE CORPORATE INSIDERS?

How can hundreds of corporate insiders be wrong? Corporate directors and officers have recently been selling stock in their companies like it may soon go out of style. The current rate of insider selling is at the highest level in two years. Many traders pay attention to what insiders do in the market, since it is commonly believed that corporate insiders have a very good handle on current market trends and that they have a superior outlook for their particular industry.  Because of this “informed” selling, many traders have come to the conclusion that current valuations for stocks are too high given the current fundamentals. If the insiders are selling, shouldn’t we be selling as well?

Along the same line of thinking, we are seeing corporations selling substantially more stock than they are buying back. Since corporations are thought to know their industry better than the general public, it is believed that this type of selling is a leading indicator of where the   price of their stock and stock index futures, in general, should be in the future. Also, there are reports that mutual funds and pensions are selling U.S. consumer stocks at the quickest rate in well over a decade.   They continue to cite the “tired consumer” as the keystone logic behind their equity position liquidation. Why have stock index futures prices continued to advance in spite of all of this “quality” selling that has come into the market?

PRICE TO EARNINGS RATIO TOO HIGH?

In addition, many of the bears believe that stock market valuations have gotten substantially ahead of themselves in light of the current relatively high price to earnings ratio of 19 for S&P 500 companies. Our belief is that even though this is the highest price to earnings ratio in five years, it is likely that better than expected increases in earnings later this year and next year will justify the current P/E ratios. 


December S&P 500 Futures – Daily  

S&P 500 Futures – Weekly     

GLOBAL ECONOMY IMPROVING

The bears continue to dismiss the bright spots that are beginning to emerge internationally. They remain undaunted even though there is more and more evidence that the worst of the global economic downturn is behind us. Our analysis continues to suggest that all of the bearish arguments will not take this market lower.  In fact, the growing number of bears makes us more comfortable with our bullish outlook.

Some of the recent bullish news is coming from the areas that were hit the hardest over the past two years. One of these is the nation’s employment situation. For example, in the week ending September 12th, jobless claims were at 545,000, which is lower than the estimated 557,000. In August, nonfarm payrolls declined by 216,000, which is better than the estimated drop of 230,000. 

Another segment of the economy, that was thought to not to be able to recover anytime soon, is the retail sales industry. However, we are seeing better numbers more recently there, as well. August retail sales were up 2.7%, when a 1.9% advance had been expected and  retail sales, excluding autos, showed a 1.1% increase, which compared to an estimate of an advance of .4%.

FEDERAL RESERVE MORE OPTIMISTIC

Data from the Federal Reserve is also becoming more upbeat. The September New York Federal Reserve Manufacturing Index was 18.88, which compared to a median estimate of 15. Additionally, the Federal Reserve released their “Beige Book” on the economy recently, which showed that 11 of 12 regional   banks reported signs of a stabilizing or improving economy in July and August. More recently, Federal Reserve Board Chairman Ben Bernanke said that he thinks the recession likely has ended, but a recovery will be moderate at best.  He said   "from a technical perspective, the recession is very likely over. I've seen some agreement among the forecasting community that we are in a recovery, but the general view of most forecasters is that the pace of growth in 2010 will be moderate.”

MARKET IGNORES BEARISH NEWS – A SIGN OF STRENGTH

Anytime a market is able to advance on bearish news it is a sign that prices are likely to move higher. Conversely, when bullish news is ignored and prices work lower it should be construed as an indication of further losses for that market in the near future. Currently we are seeing multiple cases of the bullish application of this trading rule. Bearish news continues to be ignored as futures prices advance. For example, recently it was reported that July consumer credit declined by a record $21.6 billion, when a $4 billion decline had been expected. This bearish news had no market impact, as futures continued to make new highs.

More recently, trade relations between the U.S. and China took a turn for the worse when China announced they would be initiating dumping and subsidy probes of U.S. chicken and auto products that are exported to China. This action appeared to be retaliation for the Obama administration imposing tariffs on tires from China. This bearish news took U.S. stock index futures lower in the overnight trade, but by the end of the U.S. trading session, prices actually were higher.

The application of the “opposite reaction to the news indicator,” which is one of the better techniques used to predict   price trends, is telling us that higher stock index futures prices lie ahead. 


S&P 500 Futures – Monthly



A MULTI-YEAR BULL MARKET EMERGING

Our fundamental analysis continues to suggest that the worst of the global economic downturn is behind us and that there will be an economic recovery that gradually accelerates. 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 and there will not be a double dip recession. We continue to believe that we are in the early stages of a multiyear bull market for stock index futures. Continue to trade stock index futures from the long side on weakness. 

If you would like more information about 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.