For the mid-week ending March 4, 2014, the Dow and S&P 500 are slightly down entering another area of consolidation. Other news items: U.S. service sector growth accelerated in February; private job growth is the slowest in six months; and consumer spending is expected to rise quickly in the next few months.
After a big start to the week on Monday, profit-taking brought the markets down on Tuesday and Wednesday. Investors are now wondering if profit-taking will lead to further downward movement. Given the adage “buy low, sell high”, investors are nervous that the recent record highs will lead to more selling and the start of an adjustment. With the bull market entering its sixth year, it’s a little disconcerting that the Dow dropped nearly 200 points (or 1 percent) on Tuesday and Wednesday (the worst two-day drop since January). For now, the pundits attribute the drop to profit-taking; but some are speculating that the overvaluation of stocks (the S&P 500 P/E ratio is at 17.6, the highest since 2010) will shortly lead to a market correction.
Fueling the economy is the accelerated growth in the U.S. services sector. Markit, a financial data firm, said its Purchasing Managers Index (PMI) rose to 57.1 in February, the highest level since October. Markit chief economist, Chris Williamson, believes that the current pace of expansion will not lead to a rate hike anytime soon. However, a sustained robust job market will encourage the Fed to raise rates sometime this year.
U.S. private-sector job creation grew at a slower rate than expected in February, per the ADP report. Companies added 212,000 new jobs last month after a strong 250,000 showing in January. Most of the gains were in the services sector (181,000 jobs); a bright spot is the 15,000 job increase in financial services (the largest gain since March 2006). Despite the decline, Moody’s economist Mark Zandi believes employment will continue to improve. At its current rate of job growth, Zandi believes the economy will reach full employment within 18 months.
Both Wall Street and the Fed believe consumer spending will begin a rapid increase in the coming months. This expectation is based two factors: improvements in the labor market, and a drop in energy prices. Both factors, historically, have put more discretionary money in the consumer’s pocket, leading to increased spending. Currently, gains in spending have not been as robust as expected. This is partly because consumers do not believe low gas prices are permanent, so the additional money is being saved (not spent). The lag between price drops and increased spending is generally nine months.
For option traders, it is now suggested using Put credit spreads at 2.0+ standard deviations. The expected price of the SPX at the close on Friday will fall within 2070 – 2132 (or 2 standard deviations).
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