Let’s take a look back at what was a pretty good week for stock market bulls. The SPX was up nearly 4% for the week, with every major sector gaining ground, led by the financials and consumer discretionary stocks. Small caps outpaced large caps. It was a fairly typical reaction that fit with the Summer’s trading pattern. Commentary typically attributed the moves to a positive surprise in the midweek ISM Manufacturing data, but I frankly don’t buy it – the rest of the news flow wasn’t so encuraging. The stock market was oversold and the bears had become a little too comfortable. I called this reversal last weekend based on the technical picture alone.
As usual, on the flip side, the wildly overbought bond market began to come off its highs, the 10 and 30 year Treasuries falling as we predicted at the end of last week. The yield curve, which had been flattening steadily, backed up a bit. Selling extended to munis and investment grade corporates, but lower grade and emerging market paper gained on the risk rally.
Oil futures bounced around quite a bit and actually lost a little ground for the week, closing just under the $75 level, while natural gas bounced off a deeply oversold level and gained ~8%. Wheat seems to be finding a new support level around $23 and is holding up, though well off its early August highs. The US Dollar and its opposite, the euro, again reversed course in alignment with the risk on trade. Meanwhile BOJ intervention appears to have arrested the Yen’s rise for the time being.
Looking ahead, I see the following trading themes for the coming week and perhaps longer:
1. The SPX is in a range between 1040 and 1130. When it breaks out on either side of that price band – especially with an increase in volume – we will have our next major directional signal. My bias is to the bullish side, because a great deal of pessismism has failed to push the market to new lows. Look for a bit of a pullback, but if we see a higher low, let’s say we come back to around 1050 – 1060 and move higher, that to me would be a preliminary buying signal. The safer approach would be to wait for a break out of the trading range.
2. Major foreign stock market indices look remarkably similar to each other, and they also look a great deal like the SPX. Part of the new theme of markets moving together I suppose. Look at charts of the developed and emerging market indices, and China, Korea and Brazil along with the SPX. There isn’t much divergence, except for Brazil selling off a little bit on Friday. So much for the benefits of international diversification.
3. Bonds remain heavily overbought and ripe for a further fall. My bias here would be to lighten up on Treasuries and higher grades, and move to shorter durations and more speculative issues. Shorting the long bond via the TBT is risky, but a reasonable high probability trade. For longer term holdings the BB to A grade is to me the sweet spot here; the T Rowe Price and Vanguard high yield funds are solid choices for that asset segment. Convertibles also look attractive. Otherwise, I don’t see a good risk/reward profile in general for bonds, but that is a huge market, and there are always places to find value if you need to maintain an allocation to bonds.
4. Oil, as we’ve noted before, has been a reliable trade to buy around $70 and sell as it approaches $80. Like stocks, a move outside this price band would signal a larger directional trend. Natural gas is too weird and volatile, and though I’ve enjoyed success trading it, I see no compelling reason to play with it at this point (a big part of that is my own ignorance to be sure – there are pros who make money trading natgas). Grain futures have a generally bullish look about them but trade with caution.
That’s enough for now. Happy trading, and be careful out there. Enjoy the long holiday weekend in the US.