With earnings season underway, we saw a week that was in some ways a microcosm of the last year or more in the markets: Fear, relief, euphoria, uncertainty. Do we know anything more than we did last week? Let's look at the numbers:
Week in Review
Stocks: Generally good earnings, a US deficit deal (that turned out not to be), a Greek debt deal (that technically isn’t default, unless you’re a bondholder), or something else. Take your pick, but whatever the catalyst, the market liked the look of things last week. All of the major US indexes were up solidly, the SPX gaining better than 2%. All nine sector SPDRs finished in the green, led by the big techs (XLK) and energy majors (XLE), and even the beaten down financials (XLF) put together a rally of better than 3%. It was not all offense however; the defense also put points on the board as the utilities reached a new year to date high.
Enthusiasm for equities extended beyond US borders, as most major foreign markets also found a bid. Leading the pack were Australia, where the commodity price rally helped the All Ordinaries Composite to nearly erase the prior week’s 3% fall. Additionally, in Hong Kong, where the Hang Seng index put in a remarkably similar performance. However, the mainland lagged once again no doubt held back by nagging growth fears, as the Shanghai Composite retreated but held support just at the falling 50 DMA line.
Bonds: Thursday’s reports of debt deals on both sides of the Atlantic drove the 10-year Treasury yield briefly above 3%, but Friday’s more sobering outlook saw the yield fall back to close with a 2 handle again. Overall the benchmark was up 1.8% on the week. The long bond, on the other hand, was little changed as the yield curve flattened at the long end.
Over on the corporate credit side, trading reflected a rotation toward risk as the Dow Jones investment grade index pulled back while junk rallied nicely. Municipal bonds also had a fairly good week, and TIPS rose as well. A number of the popular Barclay’s bond ETFs made new year to date highs last week: AGG, HYG, MUB, TIP, EMB.
Commodities: The CRB index logged a fourth consecutive week of gains, but the enthusiasm was more reserved than prior weeks and did not keep pace with the moves in equities. Presumably, the low growth story is creating some drag here. WTI crude eclipsed the $100 mark on Thursday and again on Friday, before closing at $99.73 (spot price). Ever contrary, natural gas fell more than 3%. The grains, live cattle and coffee pulled back, lean hogs and sugar advanced, and copper was flat for a second week.
Gold, as we suggested last week, eclipsed $1,600 right out of the gate and then traded in choppy fashion around that level, the spot price settling at $1,599.50 at Friday’s close. Silver drew a similar pattern of trading around $40.
Currencies: The US Dollar Index fell sharply and predictably on Thursday, following news of the Greek default/rescue. The euro, which had approached the $1.40 support level on Tuesday before beginning to advance ahead of the news, jumped past $1.44. Sterling put in a second strong week against the greenback. Aussie and Canadian dollars also gained vs their US counterpart, as did yen. The Swiss franc pulled back modestly, no doubt to the relief of the SNB and business leaders across the Republic.
The Week Ahead
Stocks: The SPX has rewarded our moderate bullishness on equities by moving back above the 50 DMA and resistance at 1,340. The index is not making much headway and is range-bound over the last five months, but a host of nagging fears has failed to break it down. Earnings from the leading stocks have been very solid.
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Take out the crippled financials and a couple of badly lagging tech heavyweights, and things look quite a bit brighter. One bit of evidence: The iShares S&P 500 growth ETF is handily outperforming its value counterpart.
I have been stressing the benefit of staying with the quality stocks that are performing well, and avoiding the laggards, since the broad rally stalled earlier in the year. Indexing is enormously popular and gaining steadily in popularity thanks to ETFs and the under-performance of so many active managers, but it’s a prescription for mediocrity. There will always be a place for good stock picking. Of course it’s easier said than done, but like anything else, you have to work at it.
Bonds: While the bond market remains confused by the signals coming from policy makers, yields and prices in many sectors are bouncing around without much directional momentum. That’s fine for most bond holders. There are a couple of things going on worth noting. One is the performance of emerging market sovereign debt. After last week’s trading, the yield on Barclay’s popular fund (EMB) has fallen below 5% and offers a mere 2% premium to their medium term US Treasury fund (IEF).
That is rather remarkable, and no doubt will be interpreted as a statement on the fiscal condition of the US vs. emerging nations. To me this is very questionable. At the least I would consider lightening emerging market bonds (we have no position); there are better risk/reward propositions elsewhere. For the more adventurous, a short position might even be worth a go.
The other area of note is the steady performance of TIPs. Using the example of Barclay's fund again (TIP), you have a 5.7% share price gain year to date, along with an average yield to maturity of 2.37% as of this writing. With a total return averaging 6.76% over the last five years, this modest asset flies under the radar, but provides a decent return with few nights of lost sleep. This kind of performance isn’t going to go on forever, but for now the market seems to like TIPs (disclosure: we hold TIPs, but not TIP, in the total return portfolio).
Commodities: The CRB Index is once again finding resistance at 350, a level which also posed steady resistance throughout 2006. The action over the last four weeks has been encouraging but with the index still below 350, and still ~6% beneath the April top, we’re staying on the sidelines. The macro picture is sending mixed signals and if there is no trend to trade with, my preference is to go with dividend paying equities of commodity producers, rather than the commodities themselves which, as I keep reminding readers, carry the “negative dividend” of contract roll costs.
Gold is a more difficult call. It is on a multi-year unbroken rally and it’s frankly difficult to see a scenario which would end that rally. At present gold is consolidating the move to $1,600, and a pullback to the 1,550 - 1,560 area seems a distinct possibility. Existing long term allocations are just fine, but I would be looking for a pullback before committing new money.
Currencies: The US dollar has broken down out of the ascending triangle pattern we described in the last couple of articles and sits at near term support just above 74. The Greek situation is the story here, Washington histrionics notwithstanding. So long as risk assets retain a relatively consistent inverse relationship to the dollar these moves do matter, and the renewed weakness lends support to our cautious bullishness on equities. With the modest pullback in the Swiss franc, we may yet see an opportunity for an entry point there. The extraordinary strength in the franc has not allowed us to get in, but I would see an opportunity around $1.18.