The Week Ahead: Santa Claus Rally Underway?

Last week we saw a strong up move in risk assets as the financial markets welcomed December with bullish expectations. Let’s take a quick review before we look toward the week ahead

Week in Review

Stocks: Traders returned from the Thanksgiving holiday in a bullish mood. All major US equity indexes advanced, both the SPX and Russell 2000 adding roughly 3% as volume picked up again. In contrast to much of November, when they had been a drag on the markets, financials fully participated in the rally, gaining nearly 5%. The MSCI developed and emerging market indexes, which had seen recent selling pressure, also advanced strongly.

Bonds: Fixed income continued to retreat. The benchmark 10 year US Treasury bond yield  finished the week above 3% for the first time in nearly five months. Longer term domestic bond prices fell pretty much across the board: the 30 year Treasury fell 1.5% and closed below its 200 day moving average, the Dow Jones investment grade corporate index lost 1%, and munis fell again. The bright spots were in short maturity Treasuries and high yield corporates – the opposite ends of the risk spectrum. Foreign bonds also recovered some ground after a bout of selling on default risk fears.

Commodities: The CRB index gained 5% and finished at its best level in over two years. Virtually every commodity group moved up: oil, grains, precious metals, industrial metals. Many reached new 52 week highs. Oil finished near $90. Silver, making a parabolic move since August, gained nearly 10% in one week.

Currencies: The US Dollar index, after rallying for three weeks, found resistance at its 200 day moving average and fell back to close under 80. All of the currencies which make up the Dollar index gained against it.

The Week Ahead

Stocks: US equity markets have resumed the uptrend that began in August after the Jackson Hole conference. Volume isn’t building in the way we would like to see in a strong bull market, but money is flowing into the stock market in spite of a number of economic and geopolitical worries.

For those who watch for it, note on the weekly S&P 500 chart below that we have what looks very much like a “cup & handle” pattern developing. I personally do not put much emphasis on this, as my own experience has not shown me that this pattern is a very reliable indicator of future price moves, but given the popularity of William O’Neil’s stock market books, a number of readers may follow this signal. If I recall correctly, O’Neil’s buy point would be where the “handle” price point breaks above the right side of the “cup;” readers are invited to clarify this point.

As we move toward year end, investors should also be mindful of the tax legislation situation. If the expiring Bush era tax cuts on long term capital gains are not extended, as the market appears to be anticipating. there may be some tax driven selling. That is a risk that should be considered.

(click on chart to enlarge)

My own longer term trend indicator, which has nothing to do with this chart pattern, gave a new buy signal on the SPX. Like all rule-based trading indicators, it does give occasional “head fakes” which turn out to be false signals after a short time, especially in range-bound markets…but it is giving a buy as of this writing.

Bonds: Going back to our foundational premise that getting the inflation/deflation forecast right is essential to investment success, the bond market is speaking to us here. Treasuries yields are going up at the long end, forecasting inflation expectations. We now have a 3 handle on the 10 year along with a 4 handle on the 30 year. With this in mind, and some of the other fixed income sectors like munis and foreign sovereigns seeing volatility, government bonds don’t look to me like much of a safe haven going forward. I also don’t see a great deal of value in corporate credits, where yields still aren’t very attractive on a risk adjusted basis.

Commodities: This is a bull market in many areas. The inflationary bias is really showing up here, in spite of growth concerns in several key global markets. Are any of the commodities groups overbought in the short term? Perhaps. Can they get more overbought? Certainly. Oil, on which I have been a skeptic, looks poised to break out, but we’ll be watching the Crude Inventories report on Wednesday to see how prices react. If there is a sustained move above $90, we could see a strong upside here.

A note for investors who are not commodity traders but use commodity linked ETFs: While commodities may very well be in a long term bull market, they aren’t stocks and don’t act like stocks. Commodities are generally more volatile, and often have what amounts to a carrying cost over the long term due to derivative contract roll. That makes a long term view on commodities essentially a series of short term views, and it’s possible to have the right long outlook but still not do very well in the market if you don’t get the timing right. I may not like a particular risk/reward profile at a given moment, but that doesn’t mean I’m bearish on commodities at all.

Currencies: The US Dollar remains a key player, perhaps the key player, in the global financial markets. It has been volatile, and driving a good deal of volatility elsewhere. There will be quite a bit of news coming out of Europe in the coming week so we could see more short term volatility in the Dollar and the rest of the financial markets. Until we have a more definitive and longer term solution to the eurozone debt problems, this is going to be a factor. And of course, let’s not forget the Fed, who must have looked at last week’s payroll data with disappointment.

My position in summary: bullish on US stocks and commodities, bearish on bonds


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