Weak Economy Causes Market Sell-Off

01/10/2009 1:54 pm EST

Focus: MARKETS

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, says last week’s market selloff was caused by poor economic data, and there’s growing fear of more down side in 2009. 

The US stock market depends on economic growth, and last week’s economic data showed everything but.

The Institute for Supply Management’s (ISM) manufacturing and services data showed they remain in contraction mode as both numbers were below 50%. Housing remains a challenge as earnings from KB Home (NYSE: KBH) were weak and the Labor Department’s jobs report was anything but inspiring. The loss of 524,000 jobs and 7.2% unemployment didn’t help the broad market.

The reality shock was the rationale for the broad-based decline last week. The major indexes fell more than 4% as pressure mounted from the news.

So, where does this leave us heading into this week of trading? Mentally challenged would be my conclusion. The consensus was positive heading into last week and with the shift in sentiment back towards negative, it puts many in a state of indecision.

Technically the short-term trend remains intact. Six of the ten major sectors of the Standard & Poor’s 500 index remain in an up trend, and four remain in a trading range short term. The table below gives you the data on each of the ETFs corresponding to these sectors. If the short-term trend is broken soon, it will open the door for a retest of the November lows.

My short-term outlook is for a test of the trend line and a bounce from support. That could be followed by a potential move in the coming weeks to the October high. That seems unlikely to many following a down week and a negative outlook, but it has been my outlook for the last four weeks and until we break the short-term trend line, I’m sticking with it. 

Fundamentally the markets remain challenged. The data have still not improved, and earnings for the fourth quarter have not been impressive. Alcoa (NYSE: AA) announced a layoff of more than 13,000, Intel (Nasdaq: INTC) warned on earnings, and even Wal-Mart Stores (NYSE: WMT) surprised with revisions to earnings following the December sales data. This is a persistent problem and one that is not likely to be fixed short term.

I have read many reports projecting a slow first half of 2009 and then growth in the second half. That sounds very similar to the 2008 projections. My question is where will the catalyst to growth come from? Maybe President-elect Obama’s stimulus package will be the catalyst?

I am not convinced about that and even more importantly, how will we fund the $775 billion package? The estimates for the 2009 budget deficit are already near $1.2 trillion. Higher taxes would actually dampen the effect of any stimulus package, and economic growth may not show up at all until 2010. This is something we have to watch carefully as we manage our portfolios.

In summary, we had a bad week of trading based on more bad economic data. The negative news was expected, the reaction was emotional, and I expect to see a bounce. If I am right, my target is the October high of around 1,000 on the S&P 500. If I am wrong, my stop-loss is at a break of the short-term trend line around 860.

Jim Farrish, founder and editor of Melbourne, Florida-based SectorExchange.com, writes regularly about sectors and speaks widely about investing and money management.

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