Sep S&P E-minis posted a 6-week high on Tuesday but then faded on Wednesday and Thursday. The stock market has seen a strong rally in the past month mainly due to technical short-covering and a strong Q2 earnings season. About 78% of S&P 500 companies have reported earnings that were above expectations, which is substantially better than the typical figure of about 62%. The stock market in the past week has also received support from the favorable European bank stress tests released on July 23 and from news that new global bank capital rules were more favorable than expected. The peak of earnings season, however, is now past and the stock market will need additional catalysts to keep the rally going. The main focus will be on the economic data and the duration of the economy's current slow patch. Regarding the economic data, the market is looking ahead to Friday's Q2 GDP report (expected +2.6%) and next Friday's July unemployment report. July private payrolls are expected to see an improved increase of +110,000 versus June's +83,000.

Fundamental Outlook-Bull Market Correction-The US stock market has rallied in the past month but has yet to prove that the downward correction that began in April is over. Earnings have been very strong, but the stock market faces risks from a slower economy and from tax-related selling of stocks by high-income taxpayers who may face much higher tax rates on January 1 if the Bush tax cuts are not extended for couples making more than $250,000. On the brighter side, the S&P 500 is trading at a low forward P/E of 13.3 vs the 5-yr avg of 15.3), which reduces the downside risks and leaves room for a resumption of the bull market when the economy regains upward momentum.

T-note prices are consolidating just below the recent 1-1/4 year nearest futures high, while the yield on the 10-year T-note is mildly above the recent 1-1/4 year low of 2.85%. Bullish factors include (1) the midweek sell-off in U.S. stocks, which revived some safe-haven demand for T-notes, (2) the comment by St. Louis Fed President James Bullard that the Fed should resume purchases of Treasury securities if the economy slows and prices fall as opposed to maintaining a pledge to keep rates near zero, (3) the Obama administration's push for a tax hike on couples earning more than $250,000 when the Bush tax cuts expire on January 1, 2011, which could undercut the economy, and (4) decent demand for the Treasury's sale during the week of 2-year, 5-year and 7- year T-notes. Bearish factors centered on a decline in safe-haven demand for Treasury securities with the U.S sovereign 5-year credit default swap price falling to a new low for the year of 34 bp on Tuesday before rebounding slightly higher to 35.5 bp due to the weakness in stocks. A decline in bank risk also reduced safe-haven demand for Treasury notes. The Markit iTraxx Financial index of credit default swaps on 25 banks and insurers fell to 113.5 bp, close the lowest level since April 21. The decline in bank risk was due to the recent release of the European stress tests and softer-than-expected new capital requirements for global banks.

Fundamental Outlook-Bull Market - T-note prices remain strong with renewed stock market weakness, recent disinflation trends, and general concern about a slower economy. Yet beginning next year, Tnote yields may rise back to more normal levels near or above 4% once the economy gets back into a full recovery mode and the Fed starts tightening.

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