After three weeks of nerve wracking volatility, financial markets settled down a bit last week, but hardly anyone seemed ready to sound the "all clear" signal for investors to come out of their shelters. A sense of unease continued to weigh on the markets as we moved into a long holiday weekend in the U.S. Let's review the action and look ahead.
Stocks: U.S. stocks came out of gate strong on Monday, rallying off of severely oversold conditions, but were unable to make much headway the rest of the week. Tuesday's trading attempted to push the rally further, but failed. The large cap indexes closed near the open, while the small cap indexes actually lost ground. The NYSE composite came up just to its 200 day moving average before falling back. The bears tried to take advantage Wednesday, driving the market down in the morning session, but buyers came in to push prices back up by the close. Later in the week trading steadied and volume dropped off ahead of the holiday.
When the closing bell sounded on Friday, the indexes had finished in the green: less than .70% for the Dow Industrials, nearly 1.75% for the S&P 500, more than 2% for the NASDAQ, and better than 2.5% for the Russell 2000. Like the broader indexes, the S&P sectors saw the biggest gains in the sectors that took the heaviest losses on the way down: basic materials rose nearly 4%, consumer discretionary nearly 3%. Health care and utilities, the laggards for the week, still gained nearly 1%. The VIX, which had hit 25 the prior week, backed off sharply, and the McClellan Oscillator, which had gone to -110, came all the way up to -6, reflecting relief of the extreme short term oversold condition.
Global markets were more of a mixed bag than the U.S.; of the twelve major indexes we monitor, six were up, six down. The leader among them was Canada's TSX, gaining 2.6%, and the laggard was Russia's RTS, dropping 1.1%. In general, emerging markets and Asia showed the most weakness, but both the MSCI developed and emerging markets indexes were negative for the week.
Bonds: After falling for nine consecutive weeks, the yield on the benchmark ten year Treasury note stabilized last week, but remains under 1.75%. The long bond finished under 2.85%, while the fives are at 0.76%. The Dow Jones Corporate index sold off for a third week; the BBB yield is back above 4%, while the junk yield is up to 7.6% - but still well below the 8.2% level where it started the year. Municipal bonds continue to watch the excitement from the sidelines, remaining relatively unmoved over the month of May. TIPS were off a little last week, but overall have had a pretty good run since early April. If the outlook is for deflation, recession, or complete collapse, they seem not to have gotten the memo.
Commodities: Unlike equities, commodities could not find a bid last week. The CRB index fell nearly 3% as crude oil fought to stay above $90. The precious metals, after dropping in the first few days of trading, managed a little bit of a rally late in the week, as did some of the industrial metals. The grains, on the other hand, gave back most of the gains they recorded the previous week. Natural gas, which has been rallying off the April bottom under $2, pulled back on lighter volume.
Currencies: The U.S. dollar continued its rally, the dollar index eclipsing the January high to close above 82, a level not seen in nearly two years. The euro traded under $1.25 for the first time since June 2010, while the pegged Swiss Franc followed it down. With the dollar flying, Sterling fell below $1.57, and the Aussie and Canadian dollars under $.98 and $.97, respectively. Yen had been following the dollar to the upside, but fell back last week as Fitch downgraded Japan's debt and the Nikkei continued to slump.
The U.S. economic and earnings calendars were light, and brought little in the way of surprises. The tech sector was in the spotlight, as Dell's earnings revealed soft consumer and enterprise demand, HP announced a large round of staff reductions, and Facebook shares continued to slide. Next week's data will bring us more to consider, including U.S. GDP figures, which will shed some light on the debate as to whether the economy is still growing, or slowing down.
Of course, much attention was riveted onto Europe, as EU leaders met in Brussels. Previously taboo, there was open talk of preparations for a Greek exit, but one of the most important issues - a jointly issued euro bonds also appears to have been discussed in earnest. It is a hopeful development, but EU leaders have demonstrated an uncanny ability to snatch defeat from the jaws of victory, so any optimism at this point seems premature. Until the situation is cleaned up, the markets will continue to come under pressure.
Stocks: With the market correction arrested, as least for the moment, U.S. equity investors could breathe a little easier going into the holiday shortened week ahead, but not much easier. Though the market was extremely oversold, we did not see much of a bounce. We did see equity trading positively correlated with the currencies - the only strong up day, Monday, was also the only day on which the euro rose and the dollar index fell. Once the dollar began to move up again, the equity indexes could make little progress. Next week we will have to see if buyers are attracted by current prices. Longer term support areas, and the 200 day moving averages, are not far from current levels, so this will be important.
One of my favored market sectors, large cap tech, has been disappointingly weak during the May correction. In general, it's uncommon to have a strong market with techs not participating, and this is adding to my sense of caution. In particular, Apple (AAPL), the market leader on the way up, has looked weak after the heavy distribution of April. The good news is that we will see more attractive prices on the blue chip tech stocks (and energy stocks) we still want to own, but my sense is that buying at current levels may be premature. I still suspect we will see lower prices before we see new highs, but it is not a strong conviction. There is no clear signal that I can see here. For now we are on hold, conserving cash, and waiting to see how this all plays out.
Bonds: U.S. Treasuries, and high grade sovereigns in general, are still discounting a very poor economic outlook, with the ten year yielding under 1.75%. This is a global phenomenon: the British gilts yield on a few basis points more, while the German bunds yield an astonishing 1.37%. Nevermind the silly yields on Japanese government bonds. These negative real yields are effectively functioning like an insurance premium for investors more concerned about the return of their money than return on their money. It paints in stark relief the global economic situation the markets are confronting.
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It also gives the intrepid investor an opportunity to speculate on the probability that this outlook is mistaken. An investor who thinks the bond market has discounted an overly dire outlook can choose from a number of strategies: reallocate away from Treasuries to more speculative debt or dividend paying equities, or short Treasuries (not my preferred approach). As always, do your homework and understand what you are getting into, as well as how to get out if things should go against you.
Commodities: The U.S. dollar rally has been hard on commodities, which started to roll over back in February, ahead of stocks. Trading in many individual commodities has become quite volatile. Several - oil, corn, sugar, coffee - have undercut their December lows, Others - gold, silver, copper, wheat - have not. The CRB index has come back under the high of January 2010, the top of the move off the March 2009 bottom. In any case, the commodities are playing the same tune as the rest of the orchestra: concern about growth prospects and reluctance to take speculative long positions. As with equities, it seems prudent to stay out of the fray until there is some better indication of where all of this is going.
Currencies: The dollar index has moved above the recent highs of January. It had previously run up to the 88 - 89 range in 2009 and again in 2010. It has gone nearly straight up from 78.60 to 82.50, so we can expect to see some kind of short term pullback, but that has to be seen as a realistic target going forward. The euro meanwhile has put in a series of lower highs and lower lows since its July 2008 peak. Given the situation at hand, a test of the June 2010 lows under $1.19 is very possible. I have made the comment in response to reader questions that, in the longer term, I expect the euro to go to par or below against the dollar. If that 2010 low doesn't hold, from a technical perspective par is wide open. With the correlation between the dollar, euro and risk assets still in place, this has to be a concern for investors.