“Like we did last summer…” That song lyric may as well be Ben Bernanke’s theme song. Well the data so far this week suggests that the Federal Reserve will continue their policy called “The Twist.” If you are not familiar with this policy, it is when the Fed sells short term Treasuries and buys longer term bonds. They do this to drive down the longer term interest rates and stimulate the economy. With this week’s data and the subsequent reaction in the markets, the Fed may have more of an opening to exercise QE3.
Last Monday, the US Manufacturing activity dropped unexpectedly to the lowest levels since July 2009. The manufacturing index measured by the Institute for Supply Management, dropped to 49.7 from 53.5. Typically, when the index falls below 50, it indicates contraction in the economy. If the index were to fall below 47 it usually signals recession.
On Thursday, the ADP employment number was released. This is sometimes used as a preview for the US unemployment number released on Friday. The number was good, (179k new jobs vs. 105k expected), but continuing claims rose more than expected putting a damper on trading for the day.
Looking at the recent rise in stock prices, it is not being fueled by buying in the sectors that you would expect in a sustainable bull market. In fact, the opposite is true. The defensive sectors have been the best performers.
When the market is being led by a flight to safety, it usually preceded a drop in the equity markets. So what does this mean for the investor/trader? Well we are entering the summer doldrums for the NASDAQ. The weak data and response to the data in the markets may suggest that we should hone our shorting skills but keep out stops tight, as the Fed may act to prop up the markets. This is especially true in an election year.