Wednesday’s Futures Outlook: Can This Stock Rally Be Sustained?

Treasury market traders now have a new worry. Yesterday an article in the Financial Times warned that the U.S. may lose its AAA debt rating. This news triggered a sell-off in the June Bonds and June Notes. Both markets had just begun to exhibit signs of bottoming when the reaction to the article hit the market.

The current time period represents a lull in the financial markets or in other words, a break between Treasury auctions. This was supposed to be a time when the markets would be allowed to rally while taking a break from the excessive supply which has been hitting the interest rate markets. Additional upside pressure was to be provided by the Fed which was expected to support the Treasuries by purchasing government debt.

Instead of finding reasons to cover shorts or look for reasons to go long June Bonds and June Notes, traders are wondering if they should initiate or reestablish new short positions given the possibility of a debt rating downgrade.

Reducing the U.S. debt rating will drive up the cost of borrowing which is already pointed in that direction due to the huge supply of debt that has hit the market this year and is expected to continue throughout the year.

Short-term the June Treasury Bonds will turn the trend up on a trade through 123′04. Longerterm, interest rates appear to be on track to rise. If the market chooses to ignore the warning of a debt rating reduction then Treasuries may stabilize. If the Fed decides to increase its government asset buying program then look for the Treasuries to rally.

At this time it looks as if the Treasuries will sit in a range until either the Fed increases its government asset purchases or the U.S. debt rating is reduced.

The June E-mini S&P 500 has formed a short-term top at 927.75. Based on the range of 823.25 to 927.75, there may be a correction to at least 875.75 before new buying hits the market. Most analysts agree that the current market has run-up too far, too fast and is due for a correction to relieve some of the overbought pressure.

Stock analysts feel that the price appreciation of individual stocks cannot be supported by their projections of future earnings. Many feel that the recession is going to keep pressure on earnings but stock index traders are taking a different look at the market.

Two keys as to whether this rally can be sustained will be the direction of interest rates and U.S. economic reports. Clearly asset allocation has played a major role in this current rally. Money has been flowing out of the safety of the Treasuries and into the higher yielding stock market as aggressive traders have bet on an economic recovery.

If the Fed increases its purchases of government assets then look for the Treasuries to rise. This may draw money out of equities as traders try to lock in the relatively higher guaranteed yields in the 30-year Bonds and 10-year Notes. If more selling pressure hits the Treasuries then investors will most likely continue to pour money into the equities.

Equity traders are not too worried about whether the U.S. economy has bottomed, they just want to see bottoming action. As long as this attitude remains, stock prices will rise. Two factors could impede the rally however. One factor is the lack of undervalued stocks. Traders may drive up this market so high that they run out of undervalued stocks to buy. A second factor could be bank stock sales. Undercapitalized banks selling stock to raise capital could lead to liquidity issues.

Today’s key report is the U.S. Retail Sales. Pre-report estimates are expected to show that retail sales have stopped falling. If the report shows a greater than expected increase then Treasuries could fall sharply lower. Retail stocks should rally on better than expected retail sales news.

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