Sometimes you get it right, sometimes…not so much. Last week my short term outlook on the markets was to play defense and look for an imminent correction in commodities and US Dollar strength. Needless to say, I blew that one. Before we look at the next week, let’s review last week’s action.
Week in Review
Stocks: The rally in US stocks continued as the SPX added 1.7% for a seventh consecutive week of gains. Sector action was growth oriented, with energy and financials both up more than 3%, tech up 2%, and the defensive sectors bringing up the rear. The telecom sector actually posted losses, investors seeming to fear a margin sapping iPhone price war between AT&T and Verizon.
Bonds: 10 and 30 year Treasuries and investment grade bonds were nearly unchanged on the week, but there was renewed carnage in the muni market, with prices off ~3% as heavy mutual fund outflows continued. Foreign sovereigns, on the other hand, posted big gains on what appeared to be good news on the eurozone front – however, they did not fully recoup the prior week’s losses and remain well below October levels.
Commodities: The various commodity groups went in different directions. Oil jumped 4% on the week and closed above $92, off the high but still showing strength. Agriculture also moved up, led by a nearly 5% rise in the Dow Jones grains index. On the other hand, precious metals fell again, gold closing below the 50 day SMA for the first time in five months. Selling volume has been on the heavy side.
Currencies: The US Dollar index fell sharply to close at the support level a few ticks above 79, barely remaining in the range we have seen since November. Of course, the euro index rose just as sharply, on new optimism as mentioned above. Interestingly, with commodities rallying, the Aussie and Canadian dollars were little changed.
The Week Ahead
Stocks: The stock rally continues to roll along, and though the market looks extended according to some technical indicators, and momentum in the SPX is slowing, the trend is the trend. There is nothing to indicate that it is about to turn. I have taken some of my profits and lightened up on long positions, but am not completely out of this market. At this point I’m standing pat, waiting for a correction to add to longs, but can’t say when we will see it.
Bonds: The sudden surge in bond yields after the Fed’s QE2 announcement appears to have ended; the benchmark 10 year Treasury peaked a month ago and is spending a lot of time in the 3.3 – 3.4% range. This is rather remarkable when you consider what has been happening in the commodity markets. I have made the comment before and will make it here again: when there is an apparent disconnect in the financial markets, my tendency is to go with the bond traders. They don’t seem terribly worried. Having said that, I still don’t find yields very attractive on Treasuries or investment grade issues.
Muni yields, on the other hand, are beginning to look very interesting – they are back to levels last seen more than two years ago. Now, I’m not going to recommend trying to catch the proverbial falling knife here, but there is a case to be made for considering whether the bear case is overdone. This selloff smells of panic, and panic usually means opportunity. I took a position in a closed end muni fund in December 2008 that has been very good to me. This market is beginning to look quite familiar.
Commodities: We just made reference to commodities in the context of bond yields. In the short term oil and grains remain in confirmed uptrends but the bond market appears unfazed. Here we might benefit from taking a longer view. The CRB index has retraced very nearly 50% of the move from the June 2008 high to the March 2009 low, and sits 5% away from the 350 level, which was resistance through most of 2006 and again at the end of 2007.
Whether the index can break through that level will be very interesting. If it does not, we will be looking at a large head and shoulders top. If it does, then the June 2008 highs are wide open…and this will be a problem for stocks and bonds alike, to say nothing of the economy as a whole. At this point I’m not making a call, but staying on the sidelines until this picture resolves.
Currencies: The real action here is in the euro, with the consensus expectation seeming to be that the meeting of finance ministers on Monday and Tuesday will bring strengthened commitments to the stability of the common currency. Given the composition of the respective indexes, the rise in the euro index almost by definition equates to a fall in the Dollar index. This is a situation where the market is not moving due to normal economic activity such as balance of trade, yield differentials, etc., but due to the effects of political activity.
In that context, it’s difficult to analyze these markets in the conventional way. All of which is to say that I don’t necessarily see the recent slide in the Dollar as either fundamentally warranted or indicative of any particular direction in the markets in the short term.
In summary, for this week my outlook is cautiously bullish on stocks and commodities and neutral on bonds…but I remain overweight cash and looking for a correction to add to stock positions.
Good luck and happy trading!