Weekly Recap

The stock market was slightly lower this past week. Technology and small cap stocks suffered the worst, but the S&P 500 index lost only -0.4%. That wasn't a bad performance given the big gains last week.

The market opened the week with a sizable 10 point gain on the S&P 500 index on Monday. It was a half day of trading ahead of the Tuesday holiday and volume was light. There was little news and the gains were due to a carryover of the more positive tone that developed the prior week. There was also talk of buying by funds on the first day of the quarter.

Wednesday the market reopened and decided to give back the Monday gains. The S&P 500 index dropped 9 points on what was again a light news day. The selling was largely a reaction to the recent rally, but there was also the troubling news about the North Korean missile tests. Oil closed above $75 a barrel.

Thursday the see-saw pattern continued as the S&P bounced back 3 points. The news was mostly bearish, suggesting that the gains reflected a technical bounce as the market continued to settle in after the Fed policy statement from the week before. June same-store sales data from retailers was weak. Wal-Mart posted a meager 1.2% gain as discount chains produced the worst results. Some specialty chains had decent results, but overall, the impression was of slower growth in the consumer sector. The ISM services index dipped for June, supporting the view of a general slowdown in the economy.

Friday the market took a dive. The S&P dropped 9 points and erased all of the gains for the week. The big news was that June payrolls were up only 121,000. That originally gave a boost to stocks on the idea that slower payroll growth gives the Fed less of a reason to raise rates again. There had been talk of a surge in payrolls of as much as 300,000, which might reflect economic growth of such a magnitude that the Fed would have to keep raising rates.

The market did open higher on the news, but quickly reversed ground. Part of the reason was a large 0.5% increase in hourly earnings in the payroll data. Wage gains have been picking up and the year-over-year increase is now up to 3.9%. This is viewed as adding to inflationary pressures. The talk thus turned to higher inflation and slower economic growth - not exactly a prescription for good stock gains.

In fact, a key theme this week was that economic growth is clearly slowing. June auto sales were weak. May construction spending dipped. The June ISM manufacturing index fell to just 53.8 (a reading above 50 reflects growth) from 54.4 in May. The retail chain store data and ISM services index noted above were also both soft. Thus, although virtually all economic series still reflect growth, there is widespread slowing. Housing, manufacturing, consumer spending, and employment all are growing at slower rates.

Slower growth brings mixed blessings. It may lead the Fed to soon end the rate hikes, but it also leads to slower earnings growth. The mixed implications are a reason the market has been in a trading range for almost six months now. The S&P 500 index is little changed from where it was one-half year ago.

The focus now shifts from the macro issues such as Fed policy and economic data to the micro issue of individual corporate earnings. Monday afternoon, Alcoa kicks off the second quarter earnings season with their report. The reports get very heavy the following week.

It is expected that second quarter operating earnings for the S&P 500 in aggregate will post a very respectable 10% increase over the same quarter in 2005. The market will be particularly sensitive to warnings for second half earnings, however. On Friday, 3M warned and the stock was slammed. It is very possible that many companies express a cautious outlook given the clear indications that economic growth is slowing.

The Fed may very well be on their way to accomplishing a "soft landing." That would entail slower economic growth in the second half of the year that leads to lower inflation rates, but no recession. The current trends in the economy suggest the Fed may be very near the end of their rate hike cycle as they await the lagged impact in terms of lower inflation. But the market will remain nervous over the possibility that the Fed has already gone too far and that the economy will slow too much. Those concerns could be reflected in reactions to earnings guidance in the upcoming reports.

The broader trading range may continue until there is more clarity on the outlook for Fed policy and third and fourth quarter earnings.

-- Briefing.com