The Midwest has had more than its fair share of lousy weather during the less-than-merry month of May. Not that the markets have noticed much, as they have been on their own four-week losing streak, although more stocks did finish higher last week than those that fell.
Trouble was not restricted to the numerous tornados ripping through much of the US, as overseas the pile of debt and monetary promises continue to threaten the sovereign state of Greece and by extension many of the other governments and banks in Europe. Not to be outdone, the US is bumping up against the debt ceiling that is being held political hostage by both parties.
The economy seems to be taking on a bit of water as well, as home sales (new and existing) remain terrible, durable goods orders were weak, personal income is outpaced by inflation, and the weekly jobless claims figures remain high. The cloudburst could be Friday’s job report that has been getting modestly better over the past six months. The support of the Federal Reserve ends in June, and the currently weak data begs for additional monetary support; however, the debt problems continue to build and show no signs of abating.
Given the weather, traders may have spent much of the month at home, as trading volume last week was among the slowest all year. One bright spot was that for the week more stocks rose than fell and, after Monday’s swoon, volume was solidly on the bullish side the rest of the week. The market's technical picture has been stuck in limbo for the better part of two months, as the S&P 500 has stalled in a trading range between 1300 and 1350.
An argument can be made for both a bullish and bearish resolution to the trading range. The bullish camp can point to investors getting less enthusiastic about the markets, as the eight-week average number of bulls recorded by AAII is at its lowest level since last September. Price momentum has also fallen to multi-month low levels that usually wind up reversing at some point.
The bearish case may be less straightforward, as valuations remain higher than average and volume has been strongly bullish over the past two months – another mean reverting measure that is likely to decline before going higher still.
Finally, the ratio between new yearly highs and lows has been deteriorating and could begin favoring declining stocks in the weeks ahead. Instead of trying to guess, we’ll allow the markets to speak, but whichever way it breaks, the new trend is likely to be in place for much of the summer.
Could it be that bond investors smell something in the air? Yields on the 10-year treasury are once again pushing down toward the 3% level, confounding many pundits who have openly declared that once the Fed is done buying bonds, no one will be left to buy and yields will have to go higher. While they may be right in the very long run, over the coming weeks/months yields are likely to be driven by a combination of fear regarding debt defaults around the world (for all our ills, we can still make the payments) and a slowing economy here that may find renewed demand from equity investors moving to the bond side of the street. The bond model has been positive now for the historical average of 14 weeks, but with a very wide range, a lower yield environment can last through the summer.
The frustrating part of investing is getting too caught up in the daily/weekly market movements that when you look from a broader perspective are merely blips in a long multi-year trend. It is important to get the big picture correct before diving into the minutiae of what sectors or stocks to buy.
Here is a view from 30,000 feet. Commodity prices have doubled over the past two years, similar to the oil index rise through late ’05 – before oil stocks rose another 40% over the ensuing 30 months. While the ascent didn’t slow, the pace of that ascent did.
Stocks have handily outperformed bonds until early this year, when bonds began doing better. During the '80s into the mid-'90s, stocks and bonds moved together; however, beginning in 1994, the performance of stocks and bonds wildly diverged for relatively long periods of time. What is very uncertain is whether we are on the cusp of another long period of bonds outperforming stocks or if the markets have reverted back to their 1980s relationship of similar returns punctuated by very short periods of “domination” by one or the other. The recent market move toward more defensive stocks is a change from the past nine months and will be watched closely to determine whether it's a pause in the trend or a new long-term trend development.
The “risk on” trade made a comeback last week, but still remains below the trigger line to re-establish positions in this sector; it very well maybe that the hard decline in commodities is nothing more than a two to four week correction in an ongoing bull market. Mid-cap stocks remain the strongest part of the broader equity markets. Bond investors may be well served getting back to the basics of high grade corporate and government debt as concerns over defaults rise.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.