The market has meandered the first two days of this trading week as it awaits the much anticipated jobs report on Friday. Investors also have to digest a flat fourth-quarter GDP report after better than 3% growth in third-quarter GDP, as well as the latest comments from the FOMC. These are the five questions I am looking to get some clarity on for the rest of the week as input into my trading strategies.
1. What does the 10-year yield do now that it has hit the 2% level?
This is an important psychological level as well as a point at which significant resistance has been encountered in the past. Is the rise since the beginning of year signaling more robust economic growth in the pipeline than investors are currently modeling? Is it signaling the beginnings of inflation, or that QE3 is not as effective as QE1 or QE2 at holding down rates? I have an abiding interest in where these rates are going as the largest position within my portfolio for some time has been to be short Treasuries through the reverse Treasury ETF (TBT). However, what's driving this interest rate rise has important implications for the economy and the market. Is this a head fake, or are interest rates going higher?
2. Will the rally in Japanese equities continue?
Since Shinzo Abe won election and the Japanese Central Bank (JCB) started its version of quantitative easing, the Japanese market has been on fire and the currency has cratered against the dollar. The Nikkei is at a 33-month high on the back of the JCB's efforts. Given our market went up some 50% as QE1 acted as a massive catalyst, I think we are in the early innings of this move. I am playing this with the WisdomTree Japan Hedged Equity (DXJ). This ETF gives an investor the upside of the Japanese market while hedging for currency risk.
3. Can it get any worse in Europe?
Spanish GDP contracted 0.7% in the fourth quarter and declined 1.8% for the full year. Both measures were slightly worse than expectations. Ford (F) took a hit in the market yesterday, even on good earnings overall, as the losses in its European operations continue to worsen. The shares fell almost 5% on Tuesday as the company increased its loss estimate in Europe for 2012 to $2 billion from $1.5 billion. The crisis in Europe has been put on the back burner by the ECB actions last summer, but it is hard to see when Europe can contribute again to worldwide growth. Its economic malaise should also continue to pressure the earnings of multinationals with significant operations on the continent.
Surprises will probably continue to happen on the negative side. An evolving banking scandal in Italy is another possible fly in the ointment. The euro looks as if it is vulnerable at these levels as growth is non-existent, and I would look for the ECB to engage in its own QE program after the German elections in the summer. I am playing this by being short the Eurocurrency ETF (FXE). As the euro approaches $1.35, I would be tempted to add to or initiate a short position in the currency.
4. Will Dow 14,000 mark the top of the market?
With the market rallying happily along to the Dow 14,000 level, equities seem to be entering "overbought" territory. Investor sentiment has doubled over the last six months, and retail money (aka "dumb money") has started to flow back into stocks and stock funds for the first time in over four years. At the very least, the market is overdue for a breather. Doug Kass had an interesting take today on why he thinks the highs for the year might already be in. My own feeling is that 2013 could play out like 1994: A great January, followed by a slightly down market for the rest of the year in the face of rising interest rates and accelerating inflation. Investors who do not have a cash cushion should probably take some profits on the back of this rally.
5. How robust will job growth be?
Obviously, the Big Kahuna of economic reports this week is the January jobs report that comes out Friday. The ADP jobs report kicks this cycle off this morning. I am looking for 150K to up to 200K new jobs being created in January to start the year off. The housing recovery and repair work from Sandy should both provide tailwinds to job creation. More important to me than the unemployment rate or jobs created is the data around how many people dropped out of the workforce in the month. The entire decline in the unemployment rate over the last four years has been driven by people quitting the labor force to retire, take disability, go on welfare, or go back to school. Obviously, this is not a positive for future economic growth, productivity, or government budgets. Any rise in the labor force participation rate would be most welcome, and a decline in "job dropouts" would give investors more confidence that economic growth and job growth are indeed getting better.