Riskier assets pushed higher for the second straight week, as the markets yet again shook off an onslaught of ominous economic data. The Dow Industrials posted gains of 2.35% while the S&P 500 added 2.37%. The tech-heavy Nasdaq fared only slightly better, adding 2.95% on the week.
Risk appetite was evident beyond the equities space, as crude oil and higher yielding currencies rose against the backdrop of a falling US dollar. The euro ended the week at its highest level since May 28, closing just shy of the $1.24 handle. Recent euro-stability has been largely credited for the gains enjoyed across the risk spectrum in recent trading – of course, the Dollar Prophecy informed us of that relationship several months ago. The question, then, is a simple one: Are investors so confident in the euro as to warrant further gains for broader markets?
A number of warning signs continued to present last week, which “analysts” are certain to acknowledge following a market decline in the weeks ahead. Among many another major concerns, corporate earnings and the housing market deserve particular mention.
On the US corporate earnings front, a common theme of reduced guidance has been offered and is being attributed to two primary drivers: currency fluctuations and a nervous consumer. Meanwhile, the heightened state of corporate yield spreads over Treasuries – a concern felt by financial and nonfinancial firms, globally – has greatly reduced capital raising efforts via the credit markets, which threatens expansion and hiring going forward.
In a similar vein, the housing market remains a major, if not insurmountable, obstacle for the US economy, where strategic defaults are as common today as subprime lending was three years ago (hyperbole alert). With home prices facing further declines in the months ahead – or so homebuilders have been warning – the cycle of further strategic defaults and, therefore, further price declines begins to feed itself.
The week ahead promises to be an eventful one, indeed, as both the fundamentals and technicals are poised to collide. From a fundamental standpoint, a number of key earnings reports are on deck, including those of Oracle (NASDAQ:ORCL), Bed Bath & Beyond (NASDAQ:BBBY), Nike (NYSE:NKE) and Walgreens (WAG). Beyond the quarterly numbers, however, investors will pay particular attention to the guidance offered in order to gauge the health of the corporate and consumer landscapes in the quarters ahead.
From a technical standpoint, on the other hand, traders will look toward a developing head and shoulders pattern across equity indexes. Should the technical pattern hold its ground, the Dow and S&P 500 may have as little as 3% upside remaining ahead of a major move lower.
Securities of Interest
- Long: US dollar, Japanese yen
- Short: British pound, Banks, Homebuilders, Home Improvement Retailers, Consumer Electronics
A similar theme to that of the past couple weeks, where sector-specific weakness should be exploited, remains the guiding force going forward. Of course, the number of sectors that face declines in the months ahead is only growing, which offers additional opportunities for traders on the short-side of this market.
Over the past several weeks, I have offered homebuilders and banks as being the most likely to face weakness going forward, which remains an accurate forecast to date. However, at this point it would be safe to add select retailers to that list. Specifically, the consumer electronics and home improvement spaces are especially vulnerable to a weak consumer and are likely to offer less-than-stellar outlooks for the quarters ahead.
In the forex space, the British pound is growing increasingly attractive as a short prospect. The GBP/USD is nearing the $1.50 mark, above which it last traded on May 12. Overblown concerns of inflation in the UK have led investors to speculate on a potential rate hike out of the Bank of England in the near-term, which is about as likely as Greece making good on its long-term debt obligations.
The 1.50 handle (or slightly above) for the GBP/USD will likely prove a top for the currency pair in the medium-term. Once reached, investors can expect further declines toward the January 2009 lows of 1.35.
US dollar strength is almost certain to be mirrored in the Japanese yen, which, too, appears to have reached (or neared) a bottom against its major counterparts. The yen is especially attractive against the euro in the medium-term. The EUR/JPY is last priced at 112.25 and should find short- to medium-term downside toward the 100.00 level.
The bottom line: investors should maintain no less than a risk-neutral strategy in the weeks ahead. Should markets continue along their upward path, the opportunity cost is minimal – unless you feel that markets are going to suddenly spike 10% to 15% higher. On the other hand, should weakness return to broader markets, portfolios that are overly exposed to riskier assets would face huge losses, which the potential upside from present levels does not nearly justify.
Disclosure: Author is short MS, KBH, GBP/USD, EUR/USD