The S&P 500 index is just below its recent 6-1/4 month high after an expansion in global manufacturing activity reduced growth concerns and as Fed Chairman Bernanke said the economy has shown signs of improvement.  Bullish factors include (1) upbeat comments from Fed Chairman Bernanke who said “fortunately, over the past few months, indicators of spending, production, and job-market activity have shown signs of improvement,” (2) strength in global manufacturing activity after the Jan ISM manufacturing index rose +1.0 to a 7-month high of 54.1 and the Jan China PMI unexpectedly expanded (+0.2 to 50.5), and (3) carry-over support from strength in European stocks after the Jan German unemployment rate unexpectedly fell to a record low of 6.7% along with comments from Greek Prime Minister Papademos who said he’s “strongly committed” to reaching a debt-swap pact with bondholders.  Bearish factors include (1) the unexpected drop in Jan U.S. consumer confidence from the Conference Board (-3.7 to 61.1) and (2) comments from New York Fed President Dudley who said the U.S, economy was likely to slow this year as “more contractionary” fiscal policies and the “depressed housing market” were likely to impede economic expansion.

Fundamental Outlook—Bullish—Stock prices are just below recent highs on economic optimism from strength in global manufacturing, reduced European debt concerns, and upbeat comments from Fed Chairman Bernanke.  Threats to stock prices continue to include the European debt crisis, a slowdown in China’s growth, and impending sanctions on Iranian oil.  Other supportive factors include strong earnings, low interest rates, and reasonable valuation levels with the low forward P/E of 12.7 (vs the 5-yr avg of 14.9 and 10-yr avg of 16.7).  

 

10-year T-note prices pushed up to a fresh all-time nearest-futures high, while the 10-year T-note yield dropped to a 4-month high of 1.794%, just above September’s record low of 1.671%.  Bullish factors include (1) increased safe-haven demand for Treasuries on European debt concerns after Portugal’s 10-year bond yield rose to a euro-era record of 17.39% and as Greek debt-swap talks remain unresolved, (2) the larger-than-expected decline in the Nov S&P/CaseShiller composite-20 hone price index (-0.7% m/m and -3.7% y/y), (3) the unexpected stagnation in Dec U.S. personal spending (unchanged m/m versus expectations of +0.1%), and (4) the action by the Treasury to cut its Q1 borrowing estimate to $444 billion from an Oct estimate of $541 billion, which may ease supply pressures.  The main bearish factor was reduced safe-haven demand for Treasuries as stocks rallied sharply after strength in global manufacturing eased concern the European debt crisis will curb economic growth when the Jan ISM manufacturing index rose +1.0 to 54.1, its best level in 7 months, the Jan German PMI expanded at its fastest pace in 6 months (51.0), the Jan U.K. PMI rose to its best level in 9 months (+2.4 to 52.1), India's Jan manufacturing activity grew at the fastest pace in 8 months (+3.3 to 57.5) and the Jan China PMI unexpectedly expanded (+0.2 to 50.5).

Fundamental Outlook—Short-Term Bullish—T-note prices continue to firm due to the ongoing European debt crisis despite strong U.S. economic data that has boosted the equity market.  Other bullish factors still supporting T-note prices include the Fed’s $400 bln Operation Twist, its pledge to keep rates at a record low until at least late 2014, and Mr. Bernanke’s comment that a mortgage purchase QE3 program is a “viable option.”

 

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