The Week Ahead, Jan 31 – Feb 4

And so it began, with an unexpected catalyst, but the rally reversal we have been anticipating for the last couple of weeks appeared to arrive with the unrest in the Arab world. Let’s get into the details and look at the week ahead.

Week in Review

Stocks: The eight week winning streak of the Dow Industrials came to an end as video of tanks rolling through the streets of Cairo led stock investors to hit the sell button. Friday saw 85% down volume on the NYSE, nearly 90% on the NASDAQ. Small caps, which we noted last week were already in a correction, had been staging a recovery but gave up nearly the entire week’s gains. The SPX ended down fractionally.

Bonds: Bonds were up pretty much across the board on risk aversion, the exceptions being high yield corporates and foreign sovereigns. The 10 year Treasury yield fell again to finish at 3.32%. Emerging market bonds, which had been much in favor for so long, have had a particularly tough time of it.

Commodities: West Texas crude had a big day on Friday, reversing several days of losses, and closed up fractionally for the week – yet still finished below the $90 mark. Natural gas, whose positive price trend we noted last week, was off by more than 8%. Gold also got a Friday bounce from the fear trade, but was off for the week, as were the grains.

Currencies: The US Dollar index spent most of the week building a base just under 78, before benefiting from safe have buying on Friday. The Swiss Franc was another winner, while the euro and commodity linked currencies dropped.

The Week Ahead

Stocks: Clearly the start of the week will be dominated by events in the Middle East where, as of this writing, it looks like the Mubarak government is on its last legs and the unrest has spread beyond Egypt. This should keep stocks on the defensive, but there was a softness even before the protesters took to the streets. Earnings reports from a number of companies, such as Amazon, Ford and Microsoft, were not well received and there was a negative tone in after hours trading on Thursday. We have been looking for an imminent correction for a couple of weeks now and, while there is some debate about this in the context of news-driven selling, it really doesn’t matter. Selling is selling, and that’s enough. We’re playing defense this week.

Bonds: There is a lot of negativity on the US Treasury and municipal bond markets due to the longer term fiscal outlook, and in the long run it may well be justified, but the near term picture for bond investors looks more positive. The 10 year Treasury yield has been in a range between 3.3% and 3.5% for a couple of months now, and showed no sign of going higher in spite of rallies in stocks and commodities. Municipals are recovering from their rout and have broken out of the downtrend. The near term picture looks constructive.

Commodities: Geopolitical concerns have stepped in to check a reversal in the commodities, so the near term outlook is more positive than it otherwise would be. Oil has broken a short term uptrend and, while there may be a long side trade on the news, I prefer to stay on the sidelines for this one. Gold, which has been correcting for a few weeks, may also be the beneficiary of a brief fear trade, but the trend is down…and it seems to me it has farther to go.

Currencies: The US Dollar is at a support level, and given the situation, has a good chance to hold it. There is no denying that it has been selling off hard, but with a generalized weakness in risk assets we may well see 80 before we see 76.

In summary, for this week my position is bearish on stocks and commodities ex oil, bullish on muni bonds and Treasuries, and neutral on gold and the Dollar.

Good luck, happy trading, and be careful out there.

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