Stock Market and Economic Forecast for June 2011

 

Just as the Federal Reserve is winding down its $600-billion QE2 monetary stimulus program, the latest releases of U.S. financial data increasingly point to another slowdown in the American and global economies.

Being a technically focused analyst, I generally don’t mull over the numerous fundamental data considered to be leading or lagging indicators for the economy too much. Instead, I prefer to look for guidance to the yield chart of 10-Year U.S. Treasuries.

The global capitalization of the bond market is massively larger than the global capitalization of stocks. The trend and shift in bond yields are a reflection of the assessment of the economic outlook by seasoned professional managers handling trillions of dollars’ worth of debt securities. The bond market is a leading indicator on changes in the economy.

A quick background: the yield of 10-year Treasuries peaked out at 5.3% in mid-June 2007. The stock market subsequently topped out in October 2007 and the recession officially started in December 2007. The yield on the 10-year Treasuries eventually bottomed out around two percent in December 2008, again months before the stock market hit its lows in March of 2009.

Over the subsequent two-and-a-half years, the rebound in bond yields has been as tentative as the economic recovery, all in spite of the Fed’s unprecedented money printing labeled as “quantitative easing” (QE).

Though the stock market has extended its advance well into 2011, the yield of 10-year Treasuries, currently at 3.07%, is well below its post-recessionary high of 4.01% of April 2010. It is quite likely that the intermediate slide of the past three months will take the yield below three percent. I expect that the stock market will eventually head in the same downward direction.

The prospect of a slowdown in the economy has already cooled down the commodity markets, with the CRB Composite losing as much 10% in the last four weeks. That caused the commodity-price-sensitive Toronto and Sydney stock markets to give up as much as eight percent of their April 2011 highs, compared to the four-percent setback in the S&P 500 during the same period.

However, the charts of the major U.S. stock markets since March 2011 have formed what is known in technical analysis as a rectangular formation. Until the price of stocks breaks out decisively from the rectangle, the odds of predicting the direction of a breakout and the subsequent trend are very low. However, according to technical guidelines developed by Robert D. Edwards and John Magee, rectangles are more often consolidations rather than reversal patterns.

Bottom line: stock prices are consolidating and are more likely to advance than decline at this point in the technical picture.

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