Monday Morning Musings

I was out of the office Friday but did notice the market end the week with a thud.  The high volume reversal reveals some institutional selling was behind it.  This morning the market tried to muster some strength at the open but has since faded back into negative territory.

The May ISM index didn't help matters after it showed that the index fell to 49.0 last month from 50.7 the previous month.  The 50 level marks the line between expansion and contraction, so a reading below 50 means the manufacturing sector contracted last month.

The manufacturing index is an important economic indicator, and if this Friday's jobs report doesn't show any renewed strength I think that will put an end to the Fed QE tapering argument that has been making the rounds lately.

Asian markets were down across the board overnight.  Selling was heaviest in Japan (-3.7%).  China was down the least (-0.1%) after its manuf. PMI improved to 50.8 from 50.6 the previous month.

Europe is mixed today.  The Eurozone PMI improved to 48.3 from 47.8.  Several other PMI readings improved as well, but most still remain below the important 50 level.  ECB Pres. Draghi said tha the region's bank supervisory mechanism will become effective this month.  And Spain's PM said the country's unemployment figures due out this week will be "encouraging".

The dollar index is lower today, and that is helping boost commodities.  Oil prices are higher above $93, gold prices are back above the $1400 level to $1413.  Silver and copper prices are higher today also.

The 10-year yield is roughly flat near 2.16%.  The sharp rise in the 10-year yield lately has wreaked havoc in interest-sensitive investments.  Prices in things like preferred stocks and closed-end bond funds plummeted last week.  Skittish investors likely panicked during the action, which made matters worse.  But we have seen this sort of thing play out many times before.  And in this yield-starved world, we think it is likely investors will gravitate back into these investments once the dust settles.  Current Treasury yields are still far away from offering any real competition.

The volatility index is also spiking higher, today up 7% to 17.50.  We said last week that when the VIX is above the 15 level you can expect volatility to show up in daily trading.  That is what we saw Friday, and again today with the markets reversing early gains and moving sharply lower.  So we want to remain defensive in these environments.  The all-clear signal would be when the VIX closes comfortably below the 15 level again.

Trading comment: Volume picked up on Friday which meant more distribution.  While dip buyers could step in earlier, our best guess is that a senior index like the S&P 500 probably has a date in its future with its 50-day average (currently near 1600).  That lever will likely offer support, at least the first time around.  We still expect another push higher into quarter-end.  From there a lot will depend on how this current pullback effects investor sentiment.  If sentiment gets very defensive and pessimistic, that would be good.  But if sentiment remains too complacent then we could see a deeper summer correction.  But for now let's watch the indexes as they near their respective 50-day averages.