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Beware the drone zone

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by Peter Switzer

We are now moving into what I call the drone zone where dumb reactions to expected economic data will give active traders the impetus to sell stocks. Selling is logical anyway after a strong run since 5 June but the media will try to add one and one together and get a scary three number!

To explain my crazy mathematical equation, I’m saying one equals say, the ordinary Flash PMI reading on manufacturing in China out yesterday. Add another one, which equals professional traders using this news to sell off shares, and then this adds up to three, which is where the media – driven by bearish commentators – argue that we’re in for a big sell-off!

Now it is possible that share prices could retreat and that’s because we are due for a pullback as stocks have spiked up so hard in recent times. But it doesn’t mean that we are in a terrible situation that will not respond to QE3, the European Central Bank’s (ECB) bond buying, etc.

The simple facts are that most economic readings will be pretty ordinary because economies have been struggling for most of 2012 and that’s why QE3 et al were pulled out of the economic bag of tricks by central banks.

It’s now a waiting game to see if economic data picks up and that could take to Christmas or beyond. It could mean some drifting down, but there will be spurts up if forward or early warning indicators pick up in coming months. So jobs, business investment and factory output could take six months to react to QE3 in the US, but consumer confidence could be up in one or two months.

If US housing keeps improving these sorts of early signs of economic improvement will in fact drive up stocks and I am expecting a Santa Claus rally, provided the US election and Congress with its fiscal cliff issue does not spook investors.

Overnight the Dow was actually up despite the China PMI news. The index was up only 18.97 points to 13,596.93 but at least it was positive telling me that investors are giving stocks and QE3 the benefit of the doubt right now.

The S&P 500 was again virtually flat at 1,460.26 and the VIX or fear index is around 14 which is low, saying investors are getting more confident about stocks, though a low point on the VIX can come before a stock sell-off.

What I liked was the fact that stocks fared well even though manufacturing in China endured its 11th month in a row of contraction. The HSBC Flash China manufacturing purchasing managers’ index (PMI) was actually better in September with a reading 47.8 after 47.6 in August. Any number below 50 means contraction is happening but at least there was a small positive sign.

I think China will get more stimulation when the new leadership takes over next month and that makes me cautiously positive.
In the US overnight, leading indicators for August were down and so was factory production in the mid-Atlantic region. That’s been the case for five months, but this is why QE3 was introduced.

I’m punting on economic improvement ahead and, at the moment, most of the investors on Wall Street agree with me!

However, I am wary of the drone zone, though it will give me another chance to buy good stocks at lower prices.

Watch more from Peter on SWITZER TV.

Published on: Friday, September 21, 2012

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