The U.S. equity rally we looked for in last weekend’s article in the U.S. materialized quickly, powering the market to its largest one week gain in three years. Let’s delve into the details.
Stocks: After correcting October's rally through most of November, the market erased much of the loss in the final three trading days of the month. Volume was healthy, with more shares traded than any of the previous three weeks, all of which recorded price declines. The Dow Industrials, S&P 500 and NASDAQ all posted gains of better than 7%, and the Russell 2000 scored a rare double digit advance of 10.34% - a good year’s worth of gain in a week’s time. All four indexes are back above their 50 day moving averages, and all but the Dow are beneath the 200 day. Every S&P sector recorded solid gains, with all but the defensive consumer staples and utilities moving up more than 5%, and energy gaining over 10% on the strong move in oil. Also making big gains were the money center banks and some of the large cap materials stocks.
Global markets rose generally in line with the U.S., however China was the exception as investors feared that relaxed banking rules might signal decelerating growth: while the Hang Seng matched the 7%+ advance seen elsewhere, the Shanghai Composite actually posted a loss for the week.
Bonds: Though Treasury yields on the longer side of the curve rose, the short end fell, causing the overall curve to steepen again. The ten and thirty year are back above 2% and 3% respectively, but the fives remain below 1%. Investment grade corporate bond yields rose for a fourth consecutive week, but the lower grade yields fell as risk aversion receded. Municipal paper was again relatively steady, though it seems yields there may have bottomed. Steady also describes TIPs, which are in an unbroken three year rally.
Commodities: Commodity prices reversed a string of losing weeks, though the CRB index remains in a well defined down trend since topping in April. WTI Oil closed the week above the $100 mark, which has formed the upper bound of its trading range since the big April selloff. The Brent-WTI spread continued to narrow slightly but remains above parity. Grain prices and agricultural commodities recovered a bit of lost ground after reaching new year to date lows the prior week, but the charts still look bearish. Copper, and industrial metals broadly, saw large gains and may have bottomed in November. Gains for the precious metals were more modest, except for the 10%+ rise in palladium, but apart from gold there is little sign of strength in prices.
Currencies: As predicted in this column, the U.S. Dollar Index made a second advance toward the 80 level, and failed to break through for a second time, coming back to near term support around 78 before ending the week with a modest gain on Friday. The euro had come off support at $1.32 but looks shaky, with Friday’s trading hitting the top of the trend channel around $1.35 and backing off. Rising commodities lifted the Aussie and Canadian dollars, with the former moving back above and the latter just below below parity against their U.S. counterpart. Sterling gained slightly and seems to have support at $1.55, while Yen posted a small loss, as BOJ efforts to arrest its rise appear to have traction.
The past week brought us a variety of news and economic data. On the news front, the announcement of coordinated central bank action to provide liquidity to starved European banks coincided with the massive risk asset rally. A liquidity response to a solvency crisis is the very picture of kicking the can down the road, but market reacted positively so it is what it is.
On the economic data front, most prominent in the headlines was the unemployment rate, which came in below 9% according to the U.S. Department of Labor - the first time the 9% level had been breached since March 2009. However drilling into the numbers shows no robust employment recovery, and Q3 unit labor costs recorded by the Bureau of Labor Statistics actually fell by more than the consensus forecast. On the other hand, the good news for business is that labor productivity was higher as costs declined. Data from the vital housing sector continued to show that we have no sign of recovery there either, with new home sales volume and prices down again and missing even the negative forecast numbers. Case-Shiller 20 city Index data also came in below expectations.
Stocks: In last weekend’s article we noted the severely oversold readings in the market and alerted readers to be ready for a relief rally. Those oversold conditions were indeed relieved and the McClellan Oscillators for both the NYSE and NASDAQ ended the week near zero, indicating a return to short term equilibrium. Now that the easy trade has been booked, what next? In the first part of November I had written about the repeated failure of the S&P 500 to stay above its 200 day moving average as a caution signal. That caution proved to be warranted, as the market sold off heavily in the latter half of the month, before rallying in the final days. It should be noted that December trading began with the index again making a move to the 200 day, and on Friday it failed there again.
(click on all charts to enlarge)
Turning, as we so often do, to the action bellwether stocks, we see that Apple (AAPL) bounced off its 200 day moving average but still hasn’t generated much upside momentum, even on strong market days. As long as the stock trades under $400, it will be a cause for concern. Amazon (AMZN), which is much weaker, came up to its 200 day from below, and like the S&P, failed to get through. Moving on to a broader and longer term view, though the last week saw a rotation back toward risk, the strongest three year sector price trends appear in the defensive sectors. The financials, banks in particular, still look very weak.
In this environment, with less than robust market internals, and a great deal of event risk still facing us from Europe as well as the ongoing but often overlooked troubles in the Middle East, there are plenty of headwinds. Even so, my read on the market is that we probably saw an intermediate term bottom in October. We did some buying at that point, and went on hold in November, but are ready to add long equity positions. I do think you have to be selective here, and am not inclined to buy indexes - that is a strategy for bull markets, and this is not a bull market. Our buying and our watch list has featured beaten down blue chips that are solid cash generating businesses, and will be so for the long run. There isn’t a single glamorous name in the bunch.
Bonds: U.S. Treasuries have been the beneficiaries of the risk aversion trade, as well as an economic outlook that sees low U.S. growth for as long as anyone can reasonably forecast . Add to this the Federal Reserve extending the maturities of its holdings, and yields on Treasury debt have been driven so low that they are priced for a truly lousy economy. Whether you agree with that outlook or not, if you are responsible for putting together a portfolio that generates reasonable current income without taking undue principal risk, it’s very difficult to justify buying Treasury paper. We have been expressing a preference for corporate and municipal debt in this space for months now. However, yields on both of those classes had also fallen further than we would have liked. With the recent modest correction in corporates, their prospects look a little more attractive. For example, the yield on the iShares investment grade fund (LQD), which we hold in our income portfolio, is back above 4% as of this writing.
Commodities: With the dollar rally stalling and the perception that a European meltdown has been averted, commodity prices broke their fall. Apart from oil, and the steady bid for gold, there still isn’t much strength in commodity prices across the board. The GSCI industrial metals index and the Dow Jones agriculture index are both more than 20% off their 2011 highs. Silver is 30% off. Even at $100 oil is down more than 12% and gold is off more than 7%. It’s still difficult to be bullish on commodities.
Currencies: As described above, the U.S. Dollar Index failed again to reach the 80 level and pulled back near its 50 day moving average, as coordinated central bank action to inject dollar liquidity into the global financial system was announced. Last weekend’s article expressed my expectation for the dollar to pull back early in the week so this was not much of a surprise. Where we go from here is an open question. The recent move down in the euro didn’t reach the October low, and the dollar didn’t quite reach the October high. As long as the dollar index stays below 80 the markets should hold up. With support nearby at the 50 day, we may soon find out where this is going. As has been the pattern through much of this year, the markets will turn on what happens in Europe, and the U.S. dollar will be a key indicator.