Just to show how bizarre that very late selloff on Friday was (remember that it was ostensibly “caused” by the MSCI re-balancing, of which none of the television touts that spoke about the subject had any idea what it involved), the market decided to undo that downside rout by the end of the day yesterday, although things were a little shaky at the beginning. Of course, this unsteadiness for a good part of the day was courtesy of those who thought that because of what happened on Friday was a legitimate, rather than a contrived selloff, the “best” strategy was to sell out on the lows yesterday, particularly in Nasdaq and most S&P stocks.

This was illustrated by the fact that even though the Dow gapped open a bit higher to start the proceedings with an early gain of around 25 points, the Nasdaq had the nerve to be lower by as much as 36 at 11:30am even though the Dow was still hanging around those nominally upside levels. In addition, all of the other major averages were lower as well, and this was represented by the fact that breadth numbers at that time were awful at a worse than 1 to 2 negative downside ratio. And even the good old VIX got into the panic upside act with a very large intraday gain of 1.28 and what was that about when the Dow was always positive and the S&P was never more than eight points lower at that 11:30am worst time of the day. Perhaps it was trying to make up for the fact that it did not rise enough to satisfy its adherents after Friday’s panic-induced move to those late lows.

So what we had initially was a reversal of the recent pattern where the bad news is good news and the good news is bad news, because both of the economic reports that were released yesterday were on the weaker side, as April construction spending rose by less than expected and more importantly, the May ISM Manufacturing Survey actually declined by its fastest pace in four years and went into contraction territory with a reading of 49, down from 50.7 the month before.

But alas the bad news is good news concept ultimately did carry the day, as investors decided once again, as they had last Thursday that bad news was good for the market because this means that the Fed will keep its stimulus efforts going in full force and as a result, things really took off to the upside, with the complete opposite result of what had taken place on Friday, and isn’t this a pattern that we see more often than not as well, namely that the market does the opposite of what it had done the day before, especially in the late going. So sure enough, just as stocks accelerated to the downside on Friday late in the day, yesterday they decided to accelerate to the upside at the end of the session, just to make sure that those who try a late in the day strategy because it worked the day before will now be on the wrong side of the market the next day, so to speak.

As a result, the Dow ended with a nice closing gain of 138 but breadth numbers were actually negative at a 14/17 ratio, which is a very unusual development considering that the S&P, Nasdaq and Russell 2000 all ended positively, and this meant that the rally was not as extensive as it might have been. And the VIX, which had been higher by what appeared to be a very extended amount as mentioned earlier, finally ended with a closing loss of only .02 to 16.28, which again makes little sense in terms of a 138 point Dow advance, but I assume that the close had to be looked at in terms of where it was earlier. And what made this close somewhat more absurd was that the S&P ended with a strong gain of 9.7 points, but this is what the VIX has done lately, which one can argue is ultimately going to be bullish for stocks.

The Treasury market was actually quiet as yields stayed around that 2.12% level, toward which they have tended to gravitate lately but the dollar took a bit of a beating as the Japanese yen moved under 100 for the first time in a month on those weaker reports and this spurred some buying in the Euro as well, which moved up to 1.307. And naturally this got gold to move higher within its same recent range, and of course crude oil could not bear to miss out on the upside party as it ended with a gain of around $2 a barrel up to $93.40 after having initially been $2 dollars lower than that, but hey this is the summer and the oil companies are not going to allow the price to get below $90, it would appear at the present time.

So what caused the market to make that nice upside turnaround from its earlier sluggishness? In addition to the “bad news is good news” syndrome, we also saw another Fed official stick in his two cents, as Atlanta Fed President Lockhart said that the central bank is still committed to record stimulus measures, but might reduce this commitment in the late summer or early fall, and so it goes.

So now that another Tuesday has arrived, the question will be – are we going to make it 21 straight record Dow advances for this day, and things did start out on the upside as the Dow reached its best level of the session with a 50 point advance at 10:30am, but then decided that it wanted to go lower and as a result, it reached its low for the day with a sudden rapid decline to a 100 point loss at 1:30pm, an intraday downside reversal of 150 points.

Breadth numbers are at a negative 1/2 ratio and the VIX is higher with a .50 gain to 16.88. The Dow was being supported earlier by gains in health care issues such as MRK, which is doing very well for the second day in a row and how about INTC, which did really well yesterday and is up again today, and with MSFT and CSCO also doing better, it begins to feel like a mini-version of 1998 all over again, although none of these issues are going to do what they did in their glory years, which are still well behind them. In addition, three of the stocks that investors shunned recently, such as telecoms T and VZ and consumer issue MCD, are also rebounding a bit from recent losses.

The bond market is raising yields once again as the 10-year Note has reached its highest-level in 14 months, up to 2.13%, on speculation that you know who is going to do you know what. The Euro is sort of steady but gold prices are selling off on the same line of reasoning, namely an eventual Fed tightening.
Crude oil prices are just drifting with an upward bias.

The only economic release so far today was the April trade deficit which actually widened out from a three-year low in March on increased imports of business equipment and consumer goods, and this wider number could subtract from second-quarter G.D.P. Later in the day, we get two more Fed officials giving their take on the state of the Fed stimulus programs.

As earnings season is basically over for the first-quarter, 70% of the S&P companies have beaten their earnings forecast, which compares to the average from the last four quarters at 67% and the average from 1994 of 63%. Revenues have only beaten in 48% of the companies, and this compares to an average beat rate of 62% in the last year and 52% since 1994. Earnings are projected to gain 5%, which is now above the January estimate of 4.3% and well above the April 1st projection of only 1.5%, which is an obvious reason why stocks have done so well lately.

This week will be highlighted by the May jobs report that will be released on Friday, and the current estimate is for a gain of 165,000, which would be the same as last month and we will discuss this more as the week moves ahead. Other reports will be: Wednesday – oh, no – the ADP estimate for Friday’s jobs report, April factory orders, Fed Beige Book; Thursday – weekly jobless claims and then on Friday the big one.

First quarter earnings rose by 6.2%, increased by 5% for the second-quarter, were flat for the third-quarter and were 6.3% higher in the fourth-quarter. The current projection is now for a gain of 5% in the first-quarter of 2013.

The S&P trades at 15 times the projected 2013 earnings of $111. Earnings were $85 in 2010, $92 in 2011 and $102 in 2012. The estimate for 2013 is $111, a gain of 9%. The average P/E multiple for the S&P going back to 1954 has been 16.4 and it has been 14.4 for the last 10 year’s average.

After four consecutive quarters of negative G.D.P. growth, we have had 15 consecutive quarters of positive growth, starting with the third-quarter of 2009, every quarter in 2010, every quarter in 2011, and every quarter in 2012. G.D.P. rose by 2.2% in 2012, and is projected to increase by 2% in 2013, according to various surveys, with 2.5% in the first-quarter and then in the low 1’s for the second and third-quarters before a fourth-quarter acceleration to over 4%.

Donald M. Selkin

Don Selkin is the Chief Market Strategist at National Securities Corporation, member FINRA/SIPC, (NSC) and provides the Fair Value analysis for CNBC each morning. The commentary provided in this Market Letter is intended to provide our customers with timely market analysis and should not be considered a research report. This Market Letter may contain, and is limited to: Discussions of broad based indices; Commentaries on economic, political or market conditions; Technical analyses concerning the demand and supply for a sector, index or industry based in trading volume and price; Statistical summaries of multiple companies’ financial data, including listings of current ratings; and, Recommendations regarding increasing or decreasing holdings in particular industries or securities. This Market Letter does not make a financial or investment recommendation or otherwise promotes a product or service of the firm. This Market Letter contains only news, facts, and commentary on information previously reported from a news source believed to be accurate and reliable by the author. These news sources include the following: {Bloomberg Financial, Reuters, Associated Press}.