Early Friday Market View

October 16, 2009

Stock indices hit new lows this morning, vacillating near short term supports. Meanwhile, consumer sentiment could be a potential headwind for the market.

The S&P is back near the 50% retracement of this week's rally and its September peak at 1081/1080 (session low 1081) while the Nasdaq is holding near the 62% retracement of this week's rally and an intraday gap at 2045/2040. The Dow is holding just above a support mentioned in the 9935/9925 area (session low 9941). If this is a potential top it will take a few days to sort out. Several recent stronger tech stocks have been faltering the last few days and financials are weak. Further selling in these groups that have led could prove problematic for keeping the rally in tact.

Consumer sentiment sours despite positive economic data

The University of Michigan Consumer Sentiment index reversed direction and fell to 69.4 from 73.5 in October. The consensus expected sentiment to decline slightly to 73.3, but this goes against the typical methods for predicting sentiment. The sentiment numbers are highly correlated with gasoline prices, unemployment, the stock market, and media reports.

Over the last several weeks, unemployment growth has weakened as initial claims numbers have fallen, gasoline prices have held steady, the stock market has continued to post strong growth, and the media has constantly talked about the emerging economic recovery.

Given all this data, consumers "should" feel better about themselves. Instead, consumers seem to be giving more weight to the idea that the economic recovery is not occurring fast enough. While the data is showing the economy is getting better, consumers are not seeing day-to-day changes in their communities. The expected sentiment indicator dropped to 67.6 from 73.5. The current sentiment index fell to 72.1 from 73.4.

Consumers are also getting more worried about inflation as the one-year inflation expectation rose to 2.8% from 2.2%. The long-term consumer inflation expectation (five-year time period) increased 0.1 percentage point to 2.9%. The increase in inflation expectations is slightly worrisome for the Fed as it puts pressure on the them to raise rates before they are ready.

Please note, the decrease in consumer sentiment does not necessarily translate into decreased consumption spending. The main drivers for consumption are current/expected income and available credit. The consumer still faces difficult constraints in both sectors which will make future consumption growth difficult.

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