Market Week in Review, Oct. 4 – 8

Time to put the wrap on a week that added a little over a percent and a half to the SPX back to school rally. Beyond the SPX, the Dow closed above the round number 11K level, which seems to have attracted notice from the non-financial media, and the small caps added about 2%. The developed foreign markets index (EAFE) outpaced the developing markets but in general these were happy days for stock investors the world ’round.

Now a look at the finer details. Sector analysis shows the rotation to new leadership in cyclical sectors quite well: the week’s top three performers were materials, energy, and industrials. Odd if a double dip recession is really in the cards, but they are beneficiaries, we suppose, of a falling dollar and rising commodity prices. Defensive sectors lagged: health care, staples, and utilities, with telecom the only sector to post a loss for the week. Again, not the sort of action that would typically presage an economic slowdown…but we should note that financials and tech are struggling a bit. More about this later.

Bonds also reflected the current economic outlook nicely: the benchmark 10 year Treasury yield fell another 5%+ on the week with the expectation of Fed buying, while the 30 year yield actually rose 1%. Corporates gained a little and munis were flat, but the telling action was the 2% gain in the price of TIPs, which clearly show, together with the falling long bond price, that fixed income investors are positioning for inflation.

The week in commodities also supported the inflationary thesis. The stars of the show were the agricultural commodities, where several grains traded limit up following the corn crop report. Holders of the PowerShares agriculture ETF (ticker: DBA) enjoyed a better than 6% jump on heavy volume Friday. In the energy patch, oil approached the $85 level before settling back below $83 to end the week. Natural gas on th eother hand was pounded down 4%, but did not break the August low of $3.70. With energy and commodity prices rising, there may be a nice trade on the long side here.

Now on to the the driver of all this action: the currencies. The US Dollar continues to fall and is driving everything else higher (except bond yields, at least for now). The Yen, euro, Swiss Franc, and Aussie were all up over 1%, Sterling and Loonie a little under. Let’s mention the precious metals here; I have gone short gold, which I repeatedly say I don’t like and stay away from, because of what I see on this chart:

(click on chart to enlarge)

Now this is a bit of a dangerous trade for my taste, particularly as I put it on with leverage, and if it goes against me I won’t hesitate to close it quickly at a small loss. My hunch, however, is that the precious metals are extremely overbought and vulnerable to a sharp correction.

In summary, and looking ahead, there are some clues in the market as to what is happening here: policy is pushing the dollar lower, and the dollar is pushing certain asset classes higher. This is bullish for commodities, foreign currencies, and certain types of equities.

Don’t mistake it, however, for the type of growth driven bull market we have seen in the 80s, 90s, and 2002-07. One clue is that the techs and financials aren’t participating. Another is that Treasury bond yields are very low and still, at this point, falling. Markets are trading off dollar weakness, but it has not reached the lows of March 2008 (~71) or November 2009 (~74). There could still be support for the dollar around the 76 level, and if it reverses there, these rallies will also reverse.

This is a tradeable rally to be sure, and we’ll take it, thank you very much…but the start of a new secular bull? I don’t think so.

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