Global Markets in Review: Sanguine Investors Push Stocks Higher

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by: Prieur du Plessis

Shrugging off some lingering reminders of the credit crisis and recession, investors last week marked the one-year anniversary of the bear market low by pushing many benchmark equity indices to cycle highs.

Wall Street scaled 17-month highs on the back of easing concerns of sovereign debt defaults and increased hopes for a global economic recovery as the U.S. dollar pulled back and the CBOE Volatility (VIX) Index approached 22-month lows. The Index is also referred to as the “fear gauge” of U.S. stock markets and is used as a contrary indicator that moves inversely to equity prices, as seen in the chart below where it is plotted against the S&P 500 Index.

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Source: StockCharts.com

Meanwhile, U.S. Senate Banking Committee chairman Christopher Dodd plans to introduce a revised version of a financial regulatory reform bill on Monday. Dodd had hoped to release a bipartisan bill but has been unable to do so. Not a moment too soon, as a 2,200-page report by Anton Valukas, appointed by a U.S. court to probe the reasons for Lehman’s failure in September 2008, raised serious questions about the bank’s top management, including former CEO Dick Fuld, and auditors Ernst & Young, reported the Financial Times.

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Source: Doonesbury, SlateV.com, March 1, 2010. (Hat tip: The Big Picture)

The past week’s performance of the major asset classes is summarized in the chart below - a set of numbers indicating that a degree of risk taking has crept back into financial markets. Interestingly, similar to a number of stock market indices, investment-grade corporate bonds also scaled fresh cycle peaks, whereas high-yield bonds are testing their January highs. Although yields on U.S. government bonds did not change much on the week, the bond market was actually quite strong in light of the U.S. Treasury being able to sell $74 billion in 3-, 10- and 30-year Notes and Bonds at lower-than-expected yields. Fears of further monetary tightening in China weighed on the Shanghai Composite Index (shown in the table of global stock market performance lower down) and commodities. Gold and silver were also out of favor. (Click here for Adam Hewison’s (INO.com) latest technical analysis of the outlook for gold bullion.)

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Source: StockCharts.com

A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below.

The cyclical bull market that commenced on March 9, 2009 celebrated its first anniversary with gains across a broad front. The MSCI World Index and the MSCI Emerging Markets Index gained 1.4% and 1.8% respectively. Among mature markets, Japan (+3.7%) reached its highest close in seven weeks in expectation that further easing of monetary policy by the Bank of Japan (BoJ) on Wednesday will weaken the yen and boost exporters. The only weak spots were a few emerging markets such as China (-0.6%), Russia (-0.3%) and Venezuela (-0.1%).

Notwithstanding the huge rally since the March lows, only the Chile Stock Market General Index has been able to reclaim its 2007 pre-crisis peak and is now trading 9.3% higher. Mexico and Israel could be the next countries to eliminate the bear market losses. The Dow Jones Industrial Index and the S&P 500 Index are still 25.0% and 26.5% respectively down on their October 2007 bull market peaks.

All the major U.S. indices are back in the black for 2010 to date. The small-cap Russell 2000 Index, a clear leader among the indices, has registered 20 out of 23 up-days since the low of February 8.

Click here or on the table below for a larger image.

14-03-10-04Click to enlarge

Top performers among the entire spectrum of stock markets this week were Kenya (+8.3%), Jamaica (+6.5%), Sweden (+5.4%), Nigeria (+5.3%) and Hungary (+4.6%). Debt-burdened Greece’s austerity plans gained favor with investors, pushing the Athex Composite Share Price Index up by +3.7 for the week. At the bottom end of the performance rankings, countries included Nepal (‑3.4%), Bangladesh (-2.3%), Macedonia (-1.6%), Peru (-1.5%) and Botswana (-1.4%).

Of the 94 stock markets I keep on my radar screen, 74% recorded gains, 21% showed losses and 5% remained unchanged. The performance map below tells the past week’s mostly bullish story.

Emerginvest world markets heat map

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Source: Emerginvest (Click here to access a complete list of global stock market movements.)

Seven of the ten economic sectors of the S&P 500 Index closed higher for the week, with defensive sectors Health Care, Consumer Staples and Utilities the only ones under water.

Click to enlarge:

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Source: US Global Investors - Weekly Investor Alert, March 12, 2010.

John Nyaradi (Wall Street Sector Selector) reports that as far as exchange-traded funds (ETFs) are concerned, the winners for the week included iShares MSCI Sweden (NYSEARCA:EWD) (+5.3), Claymore/Delta Global Shipping (NYSEARCA:SEA) (+5.0%), Market Vectors Indonesia (NYSEARCA:IDX) (+5.0%), First Trust Amex Biotech (NYSEARCA:FBT) (+4.5%), Claymore/NYSE Arca Airline (NYSEARCA:FAA) (+3.9%) and iShares Cohen & Steers Realty Majors (NYSEARCA:ICF) (+3.9%).

At the bottom end of the performance rankings, ETFs included iPath DJ AIG Sugar (NYSEARCA:SGG) (-12.2%), United States Natural Gas (NYSEARCA:UNG) (-4.7%), iPath DJ AIG Natural Gas (NYSEARCA:GAZ) (-4.5%), ProShares Short Financials (NYSEARCA:SEF) (-4.1%) and ProShares Short Emerging Markets (NYSEARCA:EUM) (-2.8%).

The table below, courtesy of Bespoke, highlights the performance of key ETFs across all asset classes over the last month, six months and year.

“Over the last year, just three ETFs shown are down - Natural Gas (UNG) at ‑48%, 7-10 Year Treasuries (NYSEARCA:IEF) at -4%, and 20+ Year Treasuries (NYSEARCA:TLT) at ‑13%. The best-performing ETF shown over the last year has been Russia (NYSEARCA:RSX) with a gain of 175%. India (NYSEARCA:INP) ranks second with a gain of 165%, and the Financial sector ETF (NYSEARCA:XLF) third with a gain of 144%,” said the report.

Click to enlarge:

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Source: Bespoke, March 9, 2010.

Referring to the ballooning U.S. budget deficit, the quote du jour this week comes from 85-year-old Richard Russell, La Jolla-based author of the Dow Theory Letters. He said:

The estimates of budget deficits are so huge that they defy the ability of the average citizen to comprehend them. As the U.S. continues to create more dollars, at some point our foreign creditors are going to want higher returns (rate) before they are willing to make loans to the U.S. Rising rates would be an extreme danger to the U.S. Not only would they hurt business. Rising interest rates mean a rising cost of carrying the national debt. The process of compounding the cost of the national debt would send U.S. finances into a ‘death spiral’.

I think institutional investors are holding off on buying stocks because they don’t see stocks as safe long-term holdings. Big money investors are looking ahead to higher interest rates. That combined with current high valuations for stocks constitutes a red flag for seasoned investors. The key here is probably the action of the bond market, and particularly long-dated Treasury bonds. The 30-year T-bonds would be particularly sensitive to Treasury financing looking years ahead.

It is still not clear how the U.S. is going to finance its enormous national debt. Reneging on the debt is unthinkable. To raise taxes and at the same time cut down on spending is almost an impossibility. That leaves inflation as the most probable answer. As soon as our creditors realize our ‘way out’ is inflation, they will halt their process of lending to the U.S., or at least halt lending at current low, low rates.

Elsewhere, The New York Times reported that

the White House and Congressional leaders put Democrats on notice on Friday that they would push ahead next week toward climactic votes on the health care legislation.


Next, a quick textual analysis of my week’s reading. This is a way of visualizing word frequencies at a glance. The usual suspects such as “bank”, “China”, “debt”, “economy”, “Fed”, “market”, “policy” and “rates” featured prominently, with “Greece” taking a back seat after its prominence over the past few weeks.

Click to enlarge:

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The major moving-average levels for the benchmark U.S. indices, the BRIC countries and South Africa (where I am based in Cape Town when not traveling) are given in the table below. With the exception of the Shanghai Composite Index, the indices in the table are all trading above their 50- and 200-day moving averages.

The table provides the February lows for the various indices as these must hold in order for the cyclical bull market to remain intact. Importantly, although the Shanghai Composite Index is trading a little below its key moving averages, it is still above the February low. On the upside, a break above 3,097 is required to again put the Index on a bullish path.

The Dow Jones Transportation Index, the Nasdaq Composite Index and the Russell 2000 Index all made new cycle highs during the week, with the S&P 500 closing at exactly the same level as its January high and the Dow Jones Industrial Index still 100 points short. (The fact that the Transports recorded a new high but not the Industrials represents a so-called Dow Theory non-confirmation.) However, the indices still have more work to do in order to reach pre-Lehman levels - 1,250 in the case of the S&P 500 (i.e. a gain of 8.7% from here).

Click here or on the table below for a larger image.

14-03-10-09Click to enlarge

Using Fibonacci retracement lines, the S&P 500 is now testing the 62% retracement line drawn from the May 2008 peak to the March 2009 bottom (see purple lines). According to John Murphy (StockCharts.com), a break of this key upside target raises the possibility that the Index could retrace 62% of the entire bear market that started in the fourth quarter of 2007, in which case the potential upside target is 1,232 (see green lines).

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Source: StockCharts.com

Also commenting on the technical picture of the S&P 500, Kevin Lane (Fusion IQ) said:

Currently individual investor allocations towards equities are slightly below the mean, which puts us in a zone where, though reduced, buying power is still ample. With buying power relatively strong and the AAII Bull Sentiment Survey still at a relatively neutral reading, it’s hard to see a big correction here. What may be a likely scenario is as follows: the market continues to move up and investors, even the non-believers, start chasing stocks, putting their last bit of buying power into the market.

Bill King (The King Report) believes the stock market could make some kind of top in the next 3-6 weeks.

The recovery rally is stretched, the Fed is scheduled to end its monetization this month, volume is contracting, the usual small cap-tech rally has accelerated and April 30 is the end of the best seasonal rally period; expiration is next week and Q1 performance gaming looms. But most importantly, March and April often contain important reversals or significant declines for stocks. Curfew hour is approaching.

From London, David Fuller (Fullermoney) adds the following perspective:

All technical evidence to date suggests we have seen a normal correction to the cyclical bull market’s trend mean represented by rising 200-day moving averages. The only minor negative is that persistent rallies have replaced short-term oversold conditions with short-term overbought readings. If this matters beyond brief pauses, we would see it in the form of downward dynamics and failed upside breaks from trading ranges. However, a more important factor is likely to be the months spent by most equity indices in ranging consolidations, as they gradually worked their way over to their rising moving average mean. In the absence of downward dynamics, perhaps caused by some currently unexpected fright, stock markets remain capable of running on the upside.

On a somewhat longer-term horizon, Fuller identifies a number of possible warning signals to look out for:

1) Strong economic growth competes for capital and invites monetary tightening by central banks; 2) strong growth and too much speculation would lift oil prices over the low $80s highs for this cycle to date, towards headwind levels of $100 or more; 3) U.S. 10-year Treasury yields above 4% would be an advance warning but the real danger area is above 5%; 4) a very weak USD could undermine confidence but this is clearly not a threat today.

Although the fat lady has not yet made her appearance to signal the end of the bull cycle, the steepness of the nascent rally, together with resistance in the area of the January highs, could result in stock markets consolidating in order to work off a short-term overbought condition. On the fundamental front, tighter money does not necessarily spell a declining stock market, but turning off the “juice” will certainly remove a tailwind, making earnings growth the key determinant for generating further gains (especially in light of stretched valuations).

Economy

According to the results of the latest Survey of Business Confidence of the World by Moody’s Economy.com

There has been little change in global business confidence since the beginning of this year. Sentiment remains consistent with only a modest global economic recovery. Businesses are upbeat when broadly assessing current conditions and the outlook through this summer, but remain stubbornly cautious in their assessment of sales strength, hiring and inventories,

South Americans are the most upbeat and North Americans the most nervous. Confidence is strongest among financial and business services firms and weakest among those working in real estate and government. Manufacturing firms are in between.

Click to enlarge:

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Source: Moody’s Economy.com

Referring to the precarious debt situation of many countries, Mohamed El-Erian, co-chief investment officer of PIMCO, said on the company’s website:

Every once in a while, the world is faced with a major economic development that is ill-understood at first and dismissed as of limited relevance, and which then catches governments, companies and households unawares.

As seen in the chart below (courtesy of U.S. Global Investors), the sovereign debt-to-GDP ratio is much worse for the G-20 largest developed economies (about 100%) than for the 20 most important emerging markets (approximately 40%). The G-20 ratio is forecast to increase by another 20% over the next few years, while the emerging countries’ ratio is expected to decline as a result of smaller budget deficits.

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Source: US Global Investors - Investor Alert, March 12, 2010.

Although developed markets still have higher sovereign credit ratings (left axis) than emerging markets (right axis), the ratings of emerging markets are improving, while those of developed markets are worsening significantly.

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Source: US Global Investors - Investor Alert, March 12, 2010.

Back to El-Erian who said:

Governments naturally aspire to overcome bad debt dynamics through the orderly (and relatively painless) combination of growth and a willingness on the part of the private sector to maintain and extend holdings of government debt. Such an outcome, however, faces considerable headwinds in a world of unusually high unemployment, muted growth dynamics, persistently large deficits and regulatory uncertainty.

Countries will thus be forced to make difficult decisions relating to higher taxation and lower spending. If these do not materialize on a timely basis, the universe of likely outcomes will expand to include inflating out of excessive debt and, in the extreme, default and confiscation.

A snapshot of the week’s U.S. economic reports is provided below. (Click the links to see Northern Trust's assessment of the various data releases.)

Friday, March 12, 2010

  • Strength of February retail sales impressive, but Q1 consumer spending could show only tepid gain

  • Rebound in business inventory accumulation in store for 2010?

  • University of Michigan Consumer Sentiment Index again edges down

Thursday, March 11, 2010

  • Flow of funds: Net worth of households grew, household debt reduction continues, net lending remains a challenge

  • International trade: Decline in oil and auto imports account for narrowing of trade gap

  • Total continuing claims holding at elevated level

Wednesday, March 10, 2010

  • Budget deficits: The challenge ahead in a picture

  • Wholesale inventories: Inventory-sales ratio at record low

Considering the Fed’s Beige Book (released the week before last), David Rosenberg (Gluskin Sheff & Associates) said:

The Beige Book is very useful in terms of its timeliness and granularity to the sector level. I always make a note to check and see which industries are seeing positive and negative momentum. In the latest Beige Book the list of positives was longer than I have seen in at least the last two years (twice as many positive sectors as there were negatives).

The positive mentions are: steel, natural gas, tech (especially semiconductors), software/information services, housing (entry level), tourism, staffing firms, chemical manufacturing, rail transports, airlines (fares stabilizing, leisure and business demand improving), heavy machinery (especially mining and agriculture equipment), plastic products, health care services, negative mentions, commercial real estate, banking, commercial aircraft, automotive, coal and petrochemicals.

A majority of economists in the National Association of Business Economists’ semi-annual survey expressed the opinion, as reported by MoneyNews, that a rise in interest rates was both likely and appropriate in the next several months.

I’m a little worried that the extended period language [used in the Fed's statements] is conveying too much of a particular date to markets about interest rates,

added St. Louis Federal Reserve Bank President James Bullard.

PIMCO’s co-chief investment officer and founder, Bill Gross, on the other hand, said he was skeptical of the economy’s ability to grow without the government programs and that it was possible for “some of the Fed’s liquidity programs to come back” if recovery was uncertain, according to CNBC reports (via MoneyNews). Gross said:

When debt to GDP reaches 90%, as it looks like it will, growth slows and bad things happen. That’s the potential going forward, not a default.

Bill King is of the opinion that

the FOMC meeting next Tuesday will certify or annul the scheduled termination of quantitative easing (QE) - the monetization of mortgage-backed securities (MBS) and agencies - on March 31. The bubble meisters must also address the issue of keeping interest rates low ‘for an extended period of time’. This rhetoric is causing internecine fighting within the Fed. The financial center districts want to keep the juice flowing. Non-financial district presidents are more hawkish and concerned about inflation.

Moving across the pond, amidst debt concerns regarding the PIIGS countries (Portugal, Ireland, Iceland, Greece and Spain), the European Union released a report on Friday showing Eurozone industrial production had increased in January at the highest rate since the start of records in 1990.

Further afield, Chinese exports increased by 45.7% in February on a year-ago basis, eclipsing forecasts and providing evidence of a strong economy. However, China’s inflation rate also rose significantly in February, registering a 2.5% increase from a year before - the highest in 16 months.

According to U.S. Global Investors, the latest inflation figure surpassed the one-year deposit rate of 2.25%. Negative real interest rates may provide an additional incentive to drive asset prices higher, increasing the likelihood of the Chinese central bank raising interest rates from a five-year low.

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Source: US Global Investors - Investor Alert, March 12, 2010.

On the question of exiting from monetary stimulus, the chart below shows Citi’s estimates (via U.S. Global Investors) of upcoming rate increases in emerging countries in 2010. Higher rates are on the cards for countries where inflation pressures are building, notably Brazil and Turkey.

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Source: US Global Investors - Investor Alert, March 12, 2010.

Week’s economic reports

Date

Time (NYSE:ET)

Statistic

For

Actual

Briefing Forecast

Market Expects

Prior

Mar 10

10:00 AM

Wholesale Inventories

Jan

-0.2%

-0.1%

0.2%

-1.0%

Mar 10

10:30 AM

Crude Inventories

03/06

1.43M

NA

NA

4.03M

Mar 10

02:00 PM

Treasury Budget

Feb

-$220.9B

-$223.0B

-$222.0B

-$42.6B

Mar 11

08:30 AM

Continuing Claims

2/27

4558K

4550K

4500K

4521K

Mar 11

08:30 AM

Initial Claims

03/06

462K

445K

460K

468K

Mar 11

08:30 AM

Trade Balance

Jan

-$37.3B

-$42.5B

-$41.0B

-$39.9B

Mar 11

12:00 PM

Flow of Funds

Q4

-

-

-

-

Mar 12

08:30 AM

Retail Sales

Feb

0.3%

-0.2%

-0.2%

0.1%

Mar 12

08:30 AM

Retail Sales ex auto

Feb

0.8%

0.2%

0.1%

0.5%

Mar 12

09:55 AM

Michigan Sentiment

Mar

72.5

74.6

74.0

73.6

Mar 12

10:00 AM

Business Inventories

Jan

0.0%

0.0%

0.1%

-0.2%

Click to enlarge

Source: Yahoo Finance, March 12, 2010.

Click the links below for Wells Fargo Securities’ research reports.

Next week sees interest rate announcements by the Federal Open Market Committee (FOMC) (Tuesday, March 16) and Bank of Japan (BoJ) (Wednesday, March 17). In addition, U.S. economic data reports for the week include the following:

Monday, March 15

  • Empire Manufacturing Survey

  • Net long-term TIC flows

  • Capacity utilization

  • Industrial production

Tuesday, March 16

  • Building permits

  • Housing starts

  • Import and export prices

Wednesday, March 17

  • PPI

Thursday, March 18

  • CPI

  • Jobless claims

  • Current account balance

  • Leading indicators

  • Philadelphia Fed

Markets
The performance chart obtained from the Wall Street Journal Online shows how different global financial markets performed during the past week.

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Source:Wall Street Journal Online, February 26, 2010.

Final words
Warren Buffett said:

The person that turns over the most rocks wins the game. And that’s always been my philosophy.

(Hat tip: Charles Kirk.)

Let’s hope the news items and quotes from market commentators included in the “Words from the Wise” review will assist readers of Investment Postcards to “turn over many rocks”, i.e. research matters properly in order to take prudent investment decisions.

That’s the way it looks from Cape Town (where a blogger is finishing off this post in order to celebrate his birthday for the rest of Sunday, while Lance Armstrong and over 40,000 cyclists are battling a stiff wind in the 2010 Cape Argus cycle race).