Is It Really All About the Economy?

As we start a new week, new month and new quarter there will be plenty of data to digest and filter through. And with the new information will come new questions about the outlook of the economy. I can’t help but wander if the economic data really matters at this point in time? The numbers have gotten progressively weaker over the last four months and investors continue to put money into stocks and stocks have risen in the face of ugly declines in growth. The revisions to GDP alone have been nothing short¬†of¬†discouraging, but the market has¬†moved progressively higher.

This leads¬†me to the question, does the economy matter? Is the¬†stimulus money from¬†around the world really enough to drive¬†stocks to new levels? ¬†At this point in time the answer is — yes. The Fed is committed to buying bonds at the tune of 40 billion dollars per month until jobs kick in. China, Europe and every other nation is putting money into something to stimulate growth thus, there is plenty of money in the system, and if there isn’t, someone is willing to dump some more in all in the name of helping growth. Thus, volatility may return for the short term, but there is an underlying support to the market as a result of the stimulus. That puts all the rational reasons for the markets to move lower on hold.

This week starts with the manufacturing¬†numbers and ends with the jobs report on Friday. Both numbers are true signs of the current “soft patch” in the economy. With the ISM manufacturing number at 49.6% in August and showing contraction in the US economy, it is not expected to improve much with estimates at 49.7% for September. What if this¬†number falls further? What¬†will the reaction on Wall Street be? Will it matter? One key component of the index will be new orders. The August report was 47.1 and that was the lowest level since 2009. If new orders fall further we may get a reaction from investors.

The slowdown in the manufacturing sector has been reflected in the jobs report. In August 15,000 jobs were lost impacting the overall jobs report. Manufacturing has been one of the top sectors to add jobs since¬†2009 when the recession ended (technically). Thus, if it is leading in jobs losses now, what does that say about the current state of the economy overall? Hope springs eternal as some see all the stimulus as positive for the sector looking¬†towards 2013. The biggest question for the sector in the fourth quarter will be the “fiscal cliff” resolution from Washington, and that isn’t likely until after the election.

Putting this all together what is the expectation from the stock market? Increased volatility would be the most prudent answer I can give. Due to the fact we will be fighting what the current reports are saying about the economy, and what the hope of the stimulus is projecting about the economy. The proverbial tug-o-war of current reality versus future hope. The day to day data points are going to drive the volatility up as investors react. The last four trading days have been a perfect example of what to expect. Worry about Spain last Tuesday sent the markets lower, and hope that Spain was close to a resolution on Thursday sent the market higher. We are back to worrying.

How do we play this increased volatility? The first thing is to watch the trend. If the progression on higher highs and higher lows remains in play hang on for the ride. The S&P 500 index has been holding the 1430 mark currently. If the manufacturing data is better than expected this morning we could bounce further and maintain the current support. If the data causes a reaction 1420 is the level to hold.

Scanning the sector we find money moving back towards the defensive sectors and Treasury bonds. The migration has been modest, but that will change if the key economic reports are bad this week. We are starting the week with little on the watch list to own, and I will update it day to day based on the momentum. We are at support on many of the sectors, and like the S&P 500 in need of a catalyst. Earnings will start in the next week and that will only add to the daily volatility. Thus, manage your risk, determine your maximum levels of risk you are willing to accept and set your stops accordingly, set your exit point logically, and not when the emotions of a declining market are pushing you to make decisions.

This promises to be an interesting week as the tone will be set by both economic and global events. Prepare to do battle one day at a time.