The stock market has now fallen for six of the last seven sessions. Yesterday was particularly ugly as the S&P 500 dropped 19.41 points or 1.62%. The index is now 4.66% off the high reached the Friday before last.
I had thought the market might pull back in the wake of Quantitative Easing, but instead, the market rallied when QE2 was announced on November 3rd. I was either wrong or premature. In any event, I still believe the market is very inexpensive. Let me explain what’s been happening.
There’s been a slow exodus out of the long end of the Treasury yield. Yesterday, the yield on the 30-year Treasury got as high as 4.40%. That’s a 94-point jump from the recent low reached on August 25th.
Overall, this is a good thing. First, it shows that investors are turning against overpriced bonds and finding value in stocks. Just look at how many blue chip stocks have dividend yields that compare favorably with 10-year Treasuries.
Second, investors are now willing to take on riskier assets. During the recent unpleasantness, investors crammed themselves into anything and everything that appeared to be safe. As a result, all assets that were perceived as even slightly below “bulletproof” were tossed overboard. That’s starting to correct itself.
This is why growth has been leading value, why small-caps have been leading large, why cyclicals have been leading consumers and why stocks have been leading bonds. Very recently, we’ve seen a large shift away from mid-term bonds like the 5-year Treasury which is up 37 basis points over the last eight sessions.
I caution you not to be rattled by the past few days. The stocks on the Buy List are very strong. In particular, stocks like AFLAC (NYSE:AFL) and Reynolds American (NYSE:RAI) are fairly cheap. Wright Express (WXS) also looks good. Yesterday’s close was at $43.12 which is a very good price.
Interestingly, gold got hit hard yesterday. The contract for December delivery dropped over $30 per ounce which is 2.2%. This could mean that a Fed rate hike will come sooner than people think.
The good news today is that inflation continues to be tame. Headline inflation was up 0.2% last month and core inflation was flat. Wall Street has been expecting rises of 0.3% for headline and 0.1% for core. I just don’t get the nervousness over hyperinflation. It may come one day, but for now, the statistics say inflation isn’t a problem.
Here’s a very good clip of Tadas Viskanta on Stock Twits TV explaining that the stock market might have rallied over the past few weeks because things are really looking better.
(HT: Jeff Miller)