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For the first time in 2012, a few shadows began to appear on the sunny optimism that financial markets have displayed in the new year, even as the U.S. employment picture continues to improve. Are the bulls just pausing for a moment's rest, or have they run out of steam? Let's dig into the numbers.

Perspective

Stocks: U.S. stocks just sort of drifted through the week, with a slight upward bias in the large caps, and a downward bias in the small caps, before encountering selling pressure on Friday. The S&P 500, Dow Industrials, and NASDAQ composite all posted fractional losses for the week, while the Russell 2000, which had turned in the best performance among the major indexes in 2012, dropped more than 2%. A majority of the S&P sectors retreated on the week, the basic materials taking the worst of it with a 2% loss. The tech sector bucked the trend, gaining more than 1% as shares of Apple (NASDAQ:AAPL) powered higher, at one point approaching $500 a share.

The weakness extended to the rest of the Americas and to Europe, where all of the major equity indexes we follow posted losses, but all of the Asian indexes in our scans except the Bombay Sensex 30 recorded gains, however slight. The Shanghai composite pulled back to test the 50 day moving average on Tuesday, and turned higher, continuing the rally that began in the second week of January.

Bonds: U.S. Treasury bond yields moved higher before turning back down on Friday; we're just below 2% on the ten year, and still above 3.1% on the thirty, which is nearly unchanged from the prior week. Like the long bond, corporate yields pretty much drifted sideways, except for lower grades which sold off along with equities on Friday. Municipal bonds put in another reasonably good week after a couple of days of corrective action, which were probably long overdue. Action in TIPS was a bit choppy for that sleepy corner of the market, but there still wasn't much to get excited about.

Commodities: Oil made yet another run at $100, and briefly topped that mark on both Wednesday and Thursday before closing at $99.09. Collapsing natural gas prices appear to have put in a bottom in the $2.40 - $2.50 area, with heavy trading volume coming in the last couple of weeks. Copper attempted to resume its stalled rally, but reversed course along with other risk assets on Friday; however it has held above the 200 day MA, which it recently crossed. Gold began the week on a positive note but gave back all of those gains, closing at $1,725.

Currencies: The U.S. Dollar Index put in another flat week, thanks to a pop on Friday which erased the early losses. Short term support appears to be at 78.50. The euro, Sterling, and the Aussie and Canadian dollars all moved lower against the greenback. Meanwhile Yen has been falling sharply ahead of next week's BOJ policy meeting and the release of Japanese GDP data.

Outlook

It was a light week for U.S. economic news and data. Though first time unemployment claims extended their run of positive surprises, continuing claims ticked back up. However the focus returned to the situation in Greece and Europe more broadly. While the antics in the Greek government grabbed the headlines, the S&P downgrade of a wide range of Italian banks and financial institutions is the greater worry, even if it did come as no surprise. Next week brings us more data including retail sales and housing starts, as well as the release of FOMC minutes and scheduled speeches by regional Fed Presidents Plosser (Philly) and Lockhart (Atlanta).

Stocks: As we move toward the end of earnings season, stocks have enjoyed a nice run. In this column we have been anticipating some short term weakness to consolidate gains and work off some of the excesses. It looks like we are getting exactly that. On Friday, the equity indexes pulled back and the VIX and Dollar Index turned up, indicating a measure of risk aversion coming into the markets. The McClellan Oscillator has moved into negative territory on both the NYSE and NASDAQ, while the longer term Summation Index on both markets has just begun to turn down from very high levels. My read on this is that the bulls are just pausing for a breather. Volume on the down days has been lighter than on the up days. Of course, some disaster could emerge from Europe, or the Middle East, or really just about anywhere, but there is nothing that indicates the market is in danger of a major decline at this point.

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The action in the Asian equity markets is also encouraging. The larger and more mature markets may no longer be the canaries in the coal mine that they were in years past, but any serious bout of global risk aversion would likely show up there, and the fact that they are continuing to show relative strength is a positive factor in our outlook. At this point we are taking measure of the markets, identifying stocks we would like to own, and looking for entry points. This little bit of a pause in the markets may not last more than a few days, so we're ready to move fairly quickly.

Bonds: Not much news in the bond market. One item that did catch my attention was the widely quoted comment from GMO chief Jeremy Grantham that his firm is "literally running out of superlatives to describe how much we hate bonds." While that seems a little strong, and we continue to be fully allocated to bonds in our income portfolio, I do share the general sentiment. The secular bull market in bonds is entering its fourth decade, and it's difficult to see good risk/reward when deploying money in the bond market. However, don't forget that the Fed and other central bankers "have your back" on current holdings, so we're not very worried about wild spikes in yields crushing our principal. All the same, bond holdings and complacency are not a good combination at this stage. My outlook: hold bonds if they are still appropriate for the purpose you bought them for, but be choosy and for goodness' sake pay attention to them.

Commodities: The CRB index has been moving sideways since the start of the year, and has made a series of lower highs since coming off the October bottom. WTI crude oil has been drifting along with a downward bias. We're seeing similar action in the agricultural commodities. It's not very inspiring. The one area we like is the precious metals. In last week's article I mentioned we bought gold the day after the Fed. This is somewhat unusual for us as I am generally not a fan of the barbarous relic, but the macro case looked compelling. Since then it hasn't made a great deal of progress. Friday's action was encouraging however: on a day that saw the U.S. dollar rally and risk assets sell off, gold was down in the morning but recovered in the afternoon session to close near the high for the day. So far so good, we're still holding.

Currencies: The U.S. dollar, as mentioned above, has found near term support and the larger trend still looks to me like it's going higher. Much depends on what happens with the euro; the ECB is still pumping out liquidity, and a rate cut still has to be seen as a good possibility, despite protestations to the contrary. A falling euro and an improving U.S. economy would likely put more strength into the dollar. The signals coming from the Fed are still more difficult to read, even though the Chairman is being very direct in his comments on the housing market, and admonitions to Congress to take up its fiscal tools. There just doesn't seem to be much appetite for it on Capitol Hill.

Source: The Bulls Are Pausing For A Breather