Interesting Times in the Equity Markets

[Excerpted from Bill Cara's Daily Report]

These are indeed interesting times. US equity markets closed Friday at new highs for the year. They started in rally mode because of the past two day’s rally in Shanghai stocks that followed a drubbing the day before that. Then at 10am ET, there was some positive (though well-hyped) Existing Home Sales data for July, followed later in the day by comments from Fed chairman Bernanke, saying prospects for recovery “appear good”.

During the day, according to Knobias, “Brian Madigan, head of the Fed's division of monetary affairs, defended the steps the Fed has taken to ease the pain in credit markets. He noted that the current economic crisis proves t hat central banks must be ready to lend freely to various types of financial firms in extraordinary ways to stem panic. Madigan also argued that central banks should have the ability to lend to important non-bank firms that are subject to bank-like runs.”

You can see where this is going, Mr and Mrs. US Taxpayer.

Accordingly, commodity prices were sent soaring. Crude Oil ($WTIC 73.91 +1.00 +1.37%, and a 10-month high) and $GOLD (953.70 +13.00 +1.38%, and zeroing in on $1,000) shot higher and the commodity price sensitive Energy (XLE +2.83%), Basic Materials (XLB +2.64%), and Industrial (XLI +2.60%) sectors all closed with more than +2.6% gains for the day, which well beat out the next big winners.

This is what we refer to as the Great Reflation play. Every time the USD rallies and the equity market sags, and these commodity prices get hammered, many traders trot out the arguments that there isn’t inflation and there is no Great Reflation play. Friday the shoe was on the other foot. But, the reasons for this rally cannot be denied. It is not based on fundamentals. PE multiples are out of sight, totally out of line with current and projected macro-economic and corporate operations data.

In other words, what’s happening is speculation, pure and simple, based on what we know about modest improvement from unsustainable financial bail-outs and economic stimulus programs. Caveat emptor.

In any case, at the closing bell to end the week, the Bulls were in control. The S&P 500 (1,026.13 +18.76 +1.86%), DJIA (9,505.96 +155.91 +1.67%) and NASDAQ Composite (2,020.90 +31.68 +1.59%) all closed at new highs for the year. Despite suffering a loss of almost -2.5% on Monday, the US market gained ground on the week.

With oil and gold prices rising, and bank shares on the mend, the Toronto Exchange Composite (10,831.18 +130.67 +1.22%) and Toronto Venture Board (1,191.95 +7.56 +0.64%) made solid gains as well.

Earlier Friday, the Austral-Asian markets were, except Shanghai (2,911.6 +4.52%), which was still recovering from Tuesday’s -4.30% loss, and India (15,240.8 +1.52%), soft. Australia (4,305.7 -1.95%), Japan’s Nikkei 225 (10,238.2 -1.40%), Hong Kong (20,199.0 -0.64%), were all considerably lower.

European stocks also soared: the French CAC (3,615.81 +3.15%), German DAX (5,462.74 +2.86%) and FTSE 100 (4,850.89 +1.98%) had solid gains across all sectors.

In the US equity market Friday, the following non-commodity price sensitive sectors were winners but also laggards: Technology (XLK), Healthcare (XLV) and Consumer Staples (XLP). Among industry groups, none were weak, again, and most were very strong.

The biggest winner of the Cara 100 company stocks was Brunswick Corp (BC +15.1%). Roll the dice. Of only 12 losers on the day among Cara 100 company stocks, the biggest loser was First Solar (FSLR -6.8%). The Solar industry prospects for revenue growth are high, but Jeffries pointed out that pricing pressure and undisciplined capital deployment are issues.

The US Dollar gave up ground for the fourth straight day ($USD 78.04 -0.34 -0.44%), which it does on Reflation Play days. In Friday’s DR, I opined that in the Great Reflation play of the day Thursday, the money was flowing more into the Banks than commodity related stocks, but the latter “may come today”, which happened. That hurt the $USD.

The Yen (105.93 -0.20 -0.19%) and British Pound (164.97 -0.07 -0.04%) were also weaker against the $USD for a second day in a row, while the Euro (143.20 +0.70 +0.49%) and Canadian Dollar (92.40 +0.54 +0.59%) gained.

When the Fed is pumping liquidity, the US long bond usually lifts. But later, the equity market usually kicks into gear, and money flows out of bonds as traders start to chase risk. That happened Friday where the US long bond plunged ($USB 118.81 -1.48 -1.23%), bringing it back to Monday levels. Treasury yields gained a lot for the 30-year (4.359 +1.17 +2.76%), 10-year (3.556 +1.21 +3.52%) and 5-year (2.550 +1.36 +5.63%) instruments. The Treasury bill yield remained at 0.160.

In precious metals trading at the close, there was quite a bounce from Friday morning, where the spot (cash) market closed as follows for: gold (953.15 +13.79 +1.47%) vs (944.16 +4.80 +0.51% 06:36am ET); palladium (278 +10 +3.73%) vs (270 +2 +0.75% 06:28am ET); platinum (1252 +24 +1.95%) vs (1237 +9 +0.73% 06:31am ET); and silver (14.15 +0.3500 +2.54%) vs (14.00 +0.20 +1.45% 06:36am ET), respectively. The prices strengthened as the Euro strengthened.

Sept futures prices at the close were as follows for the Euro [1.4336 +0.0080 +0.56%], and DJIA [9489 +169 +1.81%], and for Oct Crude Oil [73.83 +0.92 +1.25%].