To rally, stocks need Europe end game

By Edward Krudy

NEW YORK (BestGrowthStock) – After stocks wrapped up their worst month in more than a year, investors will face next week with caution as things are unlikely to get better until the Europeans force their debt crisis to an end game.

A Fitch Ratings downgrade of Spain on Friday drove the three major U.S. stock indexes down 1 percent for the day. For some investors, Fitch’s decision highlighted the need for the European Central Bank to come up with stronger response to the debt crisis before stocks will be able to rally.

The first wave of May U.S. economic data next week could bring what investors fear most: signs that shock waves from Europe are crossing the Atlantic. That would probably show up first in the two monthly ISM surveys, seen as an early reading of the U.S. economy’s pulse.

If those reports — based on statements from purchasing and supply executives in the manufacturing and services sectors — are weak, it will come down to a strong May U.S. nonfarm payrolls number on Friday to help investors keep their faith in the U.S. recovery.

“All of the macro data is going to be seen through the prism of Europe,” said John Praveen, chief investment strategist at Prudential International Investments Advisers in Newark, New Jersey. “You’ve had this huge problem in Europe. Is there any fallout from that on U.S. economic data?”

EXECS BLAME POOR PERFORMANCE ON EUROPE

Investors also need to watch for negative earnings pre-announcements. Shares of a tiny IT company called Blue Coat Systems Inc (BCSI.O: ) plummeted on Friday after it cut its outlook, citing Europe’s turmoil, while retailer Guess Inc (GES.N: ) fell after it said the weak euro would hurt profits.

On the bright side, market technicals may favor a relief rally — providing there is no bad news.

Chart-minded investors say stocks are oversold, with the Standard & Poor’s 500 Index (.SPX: ) down below its 200-day moving average.

Carmine Grigoli, chief U.S. investment strategist at Mizuho Securities in New York, also points to the widening spread between the number of S&P 500 stocks advancing and declining.

“The market (is) deeply oversold, actually almost the most oversold condition we’ve seen since the height of the (financial) crisis,” he said.

In May, the S&P 500 fell 8.2 percent in its worst monthly slide since February 2009, the month before the broad-based index hit a 12-year closing low. The Dow industrials lost 7.9

percent in May, while Nasdaq tumbled 8.3 percent.

The sharp drop marked the worst May for the S&P 500 since 1962 — and the worst for the Dow since 1940. It also called to mind the old stock market adage: “Sell in May and go away.”

END GAME IN EUROPE?

Prudential’s Praveen believes that despite slight gains in the last week of May, the U.S. stock market won;t make significant progress until the European Central Bank steps up its purchasing of government debt as the U.S. Federal Reserve did early last year.

“The end game in this European crisis, at least for the near term, is going to be if the ECB comes up with some kind of quantitative easing package,” Praveen said.

After an initial bounce, stocks have fallen further in the three weeks since the EU approved a $1 trillion safety net for indebted nations, with financial markets unconvinced that the measures are sufficient to avert the spread of the crisis.

EYES ON NEW ORDERS AND EXPORTS

The export and new orders components in the Institute for Supply Management’s surveys on the manufacturing and services sector could show early signs that weakness in Europe may be affecting the United States.

“There is a presumption that all the turmoil in Europe and the global financial markets is going to have a negative impact on the U.S. economy,” said Stephen Stanley, chief economist at Pierpont Securities in Stamford, Connecticut.

The ISM manufacturing index is due out on Tuesday, the first U.S. trading day in a holiday-shortened week, while the ISM services index is due on Thursday. Both are slated for 10 a.m. (1400GMT).

“If the data hold up pretty well, it’s going to be a bit of a challenge to the view that the U.S. economy is going to falter, but probably won’t convince the most skeptical of people,” Stanley said.

The employment index in the ISM surveys can also be an indication of how Friday’s payrolls number will shape up.

The headline number in the government’s monthly jobs reports will be clouded by temporary Census workers and investors will likely focus on the ADP’s private-sector payrolls number for a better indication of how underlying employment trends are shaping up.

“If that is north of 250,000, then the markets will react very positively,” Praveen said. “If that number comes out on the weaker side, even though the headline number may be flattered by the Census number, then we will probably have some anxiety in the markets.”

The payrolls report is due out at 8.30 a.m. Economists in a Reuters poll expect the headline number to show the economy added 503,000 jobs in May.

Stock Analysis

(Reporting by Edward Krudy; Editing by Jan Paschal)

To rally, stocks need Europe end game