Could this Be a Sign of What’s Ahead?

Investors know that markets cannot rise forever, and if anyone had forgotten, Tuesday was a healthy reminder. Despite macroeconomic data that was largely positive, the market rose in the morning and then sold off sharply and did not recover. The major economic data today signaled to the market that perhaps the impressive rally from the March lows had been right on track.

Today could have been profit taking or the beginning of something more ominous, as the good news was met with fresh fear over financials. Specifically, another round of rumors swirled around Wells Fargo (NYSE:WFC) needing a secondary offering to recapitalize and pay off TARP. Put option activity was heavy for Wells Fargo, and the VIX volatility index also attracted a lot of attention.

After the close, Wells Fargo’s CEO John Stumpf addressed concerns,

“We will pay {TARP} back, but we’re going to pay it back in a shareholder-friendly way. We are now earning capital so quickly, organically, we don’t want to dilute our existing shareholders.”

As far as macroeconomic data, the ISM Index of 52.9 showed that manufacturing was in fact expanding for the first time in a year and a half, and the better than expected results were the best since June of 2007. Pending home sales increased by 3.2% in July which was the best in two years thanks to greater home affordability and government tax rebates. Again, this greatly exceeded analysts expectations for more subdued improvement. Construction spending declined by .2%, which was a disappointment, but that was certainly not a surprise to us.

Auto sales were also strong but this number is virtually meaningless, and we will need to be average last month against the current month’s sales figures in order to normalize for Cash for Clunkers. That being said, the sales were still better than last year. The market’s behavior today seems to be a classic case of the market buying the rumors and selling the news.

Could this be a sign of what’s ahead this fall or is this simply the market taking a break for profit taking? In short, we don’t have the answer. However, we could get a big hint Wednesday morning as the ADP employment results are released prior to the market’s open. Watching the way the market reacts to the latest employment data should be very informative. We will be looking to see whether there is increased volatility to either the upside or the down.

It is clear that the markets have had a great run over the last six months, and in our opinion equities are no longer cheap. A substantial amount of economic improvement has already been priced in, and there are not going to be any major earnings reports to rally around for the next few weeks. Whether today was solely based on rumors of a struggling big bank, an opportunity for profit taking, or the start of a leg down, we are not sure. However, we are advising caution in this market environment because investor sentiment is extremely bullish, but that can change rapidly.

Shaky Start for September as Investors Sell the News

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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