Doomed To Repeat?

Good Morning. Stocks fell on Friday, making it seven losing sessions out of the last eight and cementing the fact that the sentiment relating to stocks has become overtly negative. There didn't appear to be any new negative catalysts during the day and in fact, there was actually some good news relating to the beleagaured banking sector. However, this didn't keep traders from doing some additional selling into the close.

Although we can easily argue that some of the selling could have been attributed to the idea of de-risking in response to the potential for headline risk out of the Eurozone over the weekend, it looked to us to have been a continuation of the corrective process. The indices broke to a new low for this particular move and broke down on a chart basis. As such, unless the bulls can put in a quick "V" bottom, our guess is that the bears may be destined to explore lower prices such as the levels seen during March bad-news panic.

Why would prices move lower, you ask? Assuming you are looking for something other than "just because" as an answer (which oftentimes is all a market needs), I thought I would share some research I found while sitting on airplanes over the weekend. In light of the fact that the most recent dive seemed to coincide with a big drop in the ISM Manufacturing Index released on June 1, I found it interesting that (a) big drops in the index are rare and (b) both the manufacturing sector of the economy and the stock market tend to be weak following such declines in the ISM Index.

Before I get to the data, I'd like to say that yes, there is a chance that the triple tragedies in Japan may well prove to be the cause of the big drop in the ISM Index. And therefore, the current soft patch could itself prove fleeting. However, as the saying goes, "Those who ignore history are doomed to repeat it." So, let's take a quick look at what the market and the economy have done in the past when big drops in the PMI has occurred.

On June 1, the ISM Manufacturing Index (formerly known here and still known elsewhere around the world as the Purchasing Managers Index or PMI) dropped an eye-popping -6.9 points. History shows that since 1948, there have been only nine other instances of drops in the index of this magnitude. And while there is obviously no guarantee that history will repeat (or even rhyme), I found it very interesting to learn that both manufacturing productivity as well as the stock market's performance have both been below average for the next one, three, and six month periods following such an event.

While I won't bore you with all of the details, the key is that the performance of the S&P 500 has been virtually flat for the one- and three-month periods following the big drop in the PMI and that returns were less than half the normal levels six months later. Thus, we may want to make a mental note of the levels seen on June 1st as they may prove to be key resistance for a while.

It is also interesting to note that four of the nine cases occurred during more significant market corrections. In these instances, the S&P wound up losing more than 7% after the report before making a turn higher.

What I take out of this data is that a big drop in the ISM/PMI doesn't mean a recession is looming or even likely. However, it does suggest that we could very easily see a "sloppy period" for a while in the market.

After finishing this report, I immediately turned my focus to the question of what could turn things around. In short, I'm of the mind that a quick recovery in the stock market could make everyone feel better in a big hurry, which, in and of itself could cure some problems. And unless, things deteriorate further in the U.S. economic picture, I'd be willing to bet that a resolution to the situation in Greece might be just the ticket to get prices movin' on up.

However, we need to remember that any resolution to the Greek bailout dilemma has to avoid triggering a "credit event" involving the credit default swaps. Thus, it will be important to listen for more about what the rating agencies have to say on the question of whether or not debt swaps by current bondholders would technically create a default. And on the subject of CDS's, this is one bit of history we definitely don't want to see repeated.

Turning to this morning... Although credit growth in China slowed last month and spreads are widening in Greece, Portugal and Ireland, traders in the U.S. may be eyeing an oversold condition as the futures are pointing a little higher in the early going. A falling dollar and a couple of M&A deals seem to be the primary drivers so far in the U.S.

On the Economic front... There is no economic data to review before the bell today.

Thought for the day... Remember that you can choose a peaceful mode at any point of any day...

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

• Major Foreign Markets:
  • Australia: NA
    
  • Shanghai: -0.16%
    
  • Hong Kong: +0.36%
    
  • Japan: -0.70%
    
  • France: +0.23%
    
  • Germany: +0.04%
    
  • London: +0.15%
  
  
• Crude Oil Futures: -$0.71 to $98.58
  
• Gold: -$0.30 to $1528.90
  
• Dollar: lower against the Yen, Euro and pound
  
• 10-Year Bond Yield: Currently trading at 2.935%
  
• Stocks Futures Ahead of Open in U.S. (relative to fair value):
  • S&P 500: +4.72
    
  • Dow Jones Industrial Average: +37
    
  • NASDAQ Composite: +5.46

 

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The opinions and forecasts expressed are those of David Moenning, founder of TopStockPortfolios.com and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in