Jul 26 2007
Stock market is in deep trouble without a good Q2 GDP report tomorrow
As I will show in a series of charts, the stock market is melting down and the technicals do not look good. The only thing that can prevent a further deterioration of the technicals is a strong advance Q2 GDP report tomorrow morning. Analysts believe Q2 GDP will come in at 3.2%, a bounce from 0.7% in Q1, but I believe that is way too optimistic. I am expecting a number closer to 1.7%. The advance GDP report is highly variable and there is usually a substantial revision 1-2 months down the road. If there is an upside surprise, it will be because the April to mid-May numbers were good and the mid-May to June numbers were estimated. According to various economic indicators, April to mid-May was fairly decent, but mid-May to June was absolutely horrendous. In particular, consumer spending, durable goods orders, and housing, dropped sharply in the latter half of the quarter, and a further weakening dollar likely made the net exports component in the GDP even more negative. Therefore I expect an advance GDP report near 3.2% to be severely revised downward later on.
No let me rephrase that. I think that any GDP number near 3.2% is a flat out lie by the government. I believe that for the sake of national interest, the government will lie about the GDP if necessary. We may never see a recession in the GDP numbers ever again. I’ll rant about this in a later post.
Let’s look at some charts. Remember, reading charts only puts things into perspective and hints at what comes next; however, there are no certainties.
The Russell 2000 fell through three key levels today:
1. Proven support at 810.
2. 200MA at 804.81.
3. Psychological support at 800.
The Russell 2000 also fell through a proven support level at 790, but it managed to close above that level. It is important to note that small cap stocks lead the market in both bull and bear markets because small cap stocks are more easily influenced by changing economic conditions; this fact does not bode well for the rest of the market.
What’s shocking about the chart for the S&P 500 is that it closed below that 1490 level I kept talking about. There have been previous excursions below 1490, but the S&P 500 had not actually closed below 1490. Today the S&P 500 even made it all the way down to 1465, a tad above the next support level at 1460, but it managed to close at 1482.66. Volume was high so this is a serious move to the downside.
Technically speaking, the Nasdaq is in better shape than both the Russell 2000 and the S&P 500, but there are signs that the Nasdaq is in trouble. The Nasdaq closed under its 50MA for the first time since April. There were two successful bounces off the 50MA in June and those were good times to buy. Today, however, the 50MA did not hold. It could be a fluke and the Nasdaq may reverse and go higher, but at minimum, breaking the 50MA is a serious warning. Also, this time around, the rate of change in price prior to meeting the 50MA is much higher; there is much more downward momentum this time. I consider the run from 2560.45 to 2724.74 as an aberration because that was much larger than the run from 2534.37 to 2634.60. Any aberration to the upside is likely to be countered with an aberration to the downside.
The Dow also closed below its 50MA for the first time in a long time. This index is doing much better than the rest of the market, but I believe that is because investors have been fleeing from other stocks and into the relative safety of Dow stocks. Therefore the Dow should be the last index to suffer major technical damage. Although DOW stocks are relatively safe when the economy starts to suck, don’t forget that safety is only relative. If the economy goes down the drain 1929 or 1987 style like I believe it will, there’s no reason to be in the Dow.
In the bond market, bonds are completely on fire. Last week I blogged that the 10-year yield fell below the crucial 5% level and that I was quite surprised that it fell through that level so soon. (Note: bond prices rise inversely with yield so falling yield means rising bond prices.) In that post, I claimed that the 10-year yield will fall below 4.5% by the end of 2007 but that the most likely scenario in the short term is that the 10-year yield would wobble between 5% and 5.25%. It turns out that my longer term prediction is now more likely, and my short term prediction was flat out wrong. The 10-year yield is in a freefall. It seems investors are now realizing how deep in doodoo the US economy really is.
I conclude this post with charts of the two things I own. UltraShort Russell 2000 in my brokerage account, and intermediate term bonds in my Roth IRA.
I am painfully aware that a bogaciously high GDP report tomorrow will change everything instantly, send the stock market soaring, and send bond yields higher. If that happens, my investment plans will not change because I know that number is bogus. If the market wants to believe false data and drive the market higher, fine, let them do it. The higher the market goes on bogus data, the harder it falls later on. If bond yields start going through the roof, fine with me because I’ll be able to buy more bonds at a cheaper price. All that is fine with me.
I am also aware that an extreme GDP number under 1% will make the market sink like lead in hydrogen. A big reason for the rally from March to July was the belief that the economy rebounded in Q2 from weak GDP growth in Q1. If it turns out Q2 GDP sucked, then the market will act as if the rug had been pulled from under it, and there’s a long way to fall.