Market Insider

Wednesday Look Ahead: Warmer View of Stocks Could be Temporary

As the quarter winds down, the temperature on Wall Street has warmed up quickly for stocks while investors chill on Treasurys.

But the ramp-up rally could be fleeting as investors turn their focus away from Greece to other issues like the U.S economy. Quarter-end portfolio maneuvers may also be providing some of the lift behind the more than 2 percent run up in stocks this week. Analysts do not see a more prolonged move higher until later in the summer.  The S&P , at 1296, was down 2.2 percent for the quarter Tuesday, and the Dow , at 12,188, is down just 1 percent for the second quarter.

Sellers drove Treasury prices lower Tuesday, while yields moved inversely higher. The 10-year yield edged up to 3.031 percent, well above the 2.84 percent level it was at on Friday. The euro gained 0.6 percent against the dollar, to 1.4371, in part on expectations the Greek parliament would approve austerity measures Wednesday, clearing the way for funding from the IMF and EU. 

The much-publicized end of the Fed's quantitative easing program (QE2) Thursday is also on the minds of investors, and its effect has been debatable. Traders have said Fed Chairman Ben Bernanke's failure to promote the idea of a third round of easing during his briefing last week was a negative catalyst for some who expected more from the Fed.

"It's not about QE. It's about the data, so we need to see the data come in better than where it's been coming in," said Greg Peters, chief U.S. credit strategist and head of global credit research at Morgan Stanley.

The end of QE2 is blamed by some for the shakeout in commodities, which are mostly all down for the quarter. There was also some finger pointing at the Fed after two sloppy Treasury auctions for $70 billion in two- and five-year notes this week. However, some traders said Treasurys came under selling pressure as stocks and other risk assets, like oil, rose. They also reversed some of a recent flight-to-safety trade, as the peripheral European sovereign bonds rallied on the prospects of a solution for Greece, albeit temporary.

Credit markets recovered some losses this week in commercial mortgage-backed securities and sub prime bonds. "The market has definitely weakened, and credit has underperformed in a meaningful way. Where we've seen some of the most stress and strain is in some of the securitized stuff," said Peters, noting the improvement  Tuesday. High yield has also moved sharply lower.

"I don't think there's much in the way of credit that's telling us anything different than anything else. The markets have been very worried about what's happening overseas," he said. Peters said the three big fears are the sovereign debt crisis in Europe, the issue of whether China can engineer a soft landing, and the troubling slowdown in U.S. economic data.

Peters expects the markets to improve as the economy reaccelerates in the second half, a story he says investors have only just begun to believe. "It's going to be a bumpy ride..The debt ceiling debate continues to take shape," he said. ".. I think the mix in the data will keep investors on edge. The very tough return environment, where investors have not made money...that will keep them more active in the market and trading from the Hamptons, so to speak."

What To Watch

President Obama holds an 11:30 a.m. ET press briefing Wednesday, and the budget talks and debt ceiling will be part of the discussion.

Wednesday is light on data with just April pending home sales at 10 a.m. But the market is looking past that number and focusing on Friday's ISM manufacturing data. There is talk that the number could slide below 50, which could signal a contraction. There has been chatter the number could sink as low as 45, after last week's disappointing slides in the Philadelphia Fed and Empire State manufacturing surveys.

"ISM should be weak, based on the PMIs that were already released, namely New York and Philly in addition to what we expect will be a soft Chicago, which is released Thursday," said Deutsche Bank chief U.S. economist Joseph LaVorgna. He expects ISM at 49.5 but that should represent a temporary dip as the auto industry increases production and supply chain disruptions from the Japanese earth quake end.

"It's all supply related. The PMIs in Japan have been a pretty good indicator for the U.S. ISM and they jumped significantly, and they have a two-month lead so that tells you there's going to be a jump next month in the ISM," he said. Japanese PMI for May was up 11.2 points, after declining 15 points in March and 1.0 point in April.

Barclay's Capital's Barry Knapp, chief equities portfolio strategist, said he doesn't see the ISM below 50. Just the comments from corporate America argue against it. "If you listen to what you heard from Illinois Tool Works, Caterpillar Tractor, FedEx, what you were hearing from companies was not consistent with ISM below 50," he said.

"By the same token, I don't think it's going to be a great earnings season either. I don't think it's going to be a negative one, but there should be some spots of weakness, some spots of strength. It's not as negative as people were starting to think it was a week or two ago," he said.

Knapp does not think the rebound in stocks this week signals the start of a move to new highs, and that there will be continued volatility throughout the summer. "My guess is macro economic data does not become convincingly positive until we get to something like back-to-school shopping season," he said. "The effect of earnings season on stock prices depend was where we are at the time." He expects the market to trade between 1250 and 1350 on the S&P 500.

"I really think in order to get a rally, we're going to need some constructive data," he said.

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