The month of May 2012 was an ugly one to be sure - unless you were long the dollar and Treasury bonds, and/or short the euro and all manner of risk assets. The first day of June brought another gut-wrenching drop in equities and a plunge in bond yields as discouraging economic news continued to pour in from all directions. As we look forward to the coming days and weeks, the question of the moment is...how low can it go? Let's try to find some answers.
Stocks: U.S. stocks followed up a very tough month with an even worse opening to the next one. The Dow Industrials and S&P 500 fell nearly 9% in May, while losses for the NASDAQ and Russell 2000 were in the range of 10%. Downside momentum accelerated in this final week, with prices sliding nearly 3% on Friday alone, with volume rising. Among the major indexes, only the NDX 100 remained above its 200 day moving average at the closing bell. The Dow and the Russell are in negative territory for the year to date.
Even the Dow Transports were not saved from the powerful selling pressure by falling oil prices. The only relative safe haven among the indexes was the often ignored Dow Utilities. Hardest hit sectors were energy, materials, industrials, and financials. Rotation into defensive sectors, while predictable, did not save them from participating in the losses as well.
Among global markets, the relative safe havens were in Asia; nine of the twelve major indexes we monitor, were down for the week. The gainers were China, Korea and Australia, the biggest losers, not surprisingly, were in Europe. None of their charts look particularly bullish.
Bonds: U.S. Treasury yields, slumping since the middle of March, fell off a cliff last week. The long bond traded at 2.51% at one point on Friday, and finished at 2.54%, while the ten year went to a low of 1.44% - another new record. The fives went to 0.6% before closing two basis point higher. Across the Atlantic we saw even stranger spectacles, such as a negative yield on the two year German bund. Back on the home front, the Dow Jones Corporate index was also bid up after three weeks of mild selling. Sub-investment grade yields continued to rise however - we have seen some heavy liquidation in the popular ETFs JNK and HYG over the last few weeks. TIPS continued to soar along with their conventional cousins, while munis have been a relative sea of calm amid the storm.
Commodities: The nearly across the board plunge in commodity prices continued into another week, as the CRB index dropped nearly 5%, breaking another support level on the way down. Crude oil broke right through $90 on the way to the low $80s, where it closed near the low for the week. We saw more heavy losses in the industrial metals, the softs, and the grains. The precious metals, on the other hand, found some safe haven buyers, as gold climbed back above $1,600. Natural gas plunged more than 11%.
Currencies: The U.S. dollar extended its rally into a fifth week, the dollar index moving above 83.5 before falling back Friday at 82.89. The euro fell below $1.24 before catching a small bounce. Sterling is now below $1.54, the Swiss Franc at $1.035, and the Aussie and Canadian dollars under $.968 and $.961, respectively. Yen returned to the upside, as it continues to recover from the February-March drop.
There were few bright spots in the U.S. economic calendar last week. Aside from decent auto sales and a less negative than expected Case-Shiller 20 city index, there was not much to inspire good cheer. By now everyone who is paying attention has seen the employment numbers, which were quickly turned into a political football, but there was so much more. Hourly earnings, average workweek, personal incomes, consumer confidence, Chicago PMI - every we looked, the numbers were weak. Construction spending, pending home sales...the same. And then there was the downward revision of Q1 GDP to below 2% growth.
We didn't get much help from abroad. From China, we had the official May PMI come in just above the 50 expansion/contraction line, but HSBC's alternate PMI was down to 48.4. Either way, the weakening Chinese economy is throwing off negative data points. Europe, to no one's surprise, was even worse: UK May factory PMI came in under 46, while the same measure for the euro zone fell to just above 45. Those who called a global recession in 2012 appear on the way to being vindicated, and though the expansion in the U.S. remains in place, it is weakening visibly.
Stocks: The market unfortunately appears to be moving much as I anticipated in my article of May 19th: a bounce toward 1,340 on the SPX followed by a test of the 200 day moving average. It all happened pretty quickly - we got to 1,335 on Tuesday and then broke the 200 day on Friday. At this point the market is back to oversold conditions. We could see some bargain hunting push it back above the 200 day, but there are quite a few blue chips with busted charts, so I think caution is still warranted. We're not doing any buying here, anticipating lower prices for more attractive entry points.
My next downside target for the SPX is 1,200: the support level of mid December and a 62% retracement of the entire October - March move. A failure there would set up a return to the October lows around 1,075. Again, if we do get there, we won't go in a straight line. A more likely scenario is a choppy summer market with more downside overall.
Bonds: U.S. Treasuries are pretty much in uncharted territory, and as I have recently expressed, are discounting a rather extreme economic outlook. Given the data and the situation, this may be warranted - bank runs in developed nations are not something you see every day - but I still think it's overdone. A couple of things are pretty clear, however. There has been capital flight from Europe as well as from China (see Cam Hui's excellent work in this area). No doubt much of this is finding its way into the U.S. high quality debt markets. It's as much about currencies as about yield: an investor whose liquidity is denominated in euros and is bearish on that currency can make a nice return by converting that liquidity into safe U.S. dollar denominated assets.
I still think, over the longer term, that the Treasury market will be an attractive short, but have repeatedly cautioned investors that it is too early. Be patient and let it come to you. For the income oriented investor, as I have recently stated, there will soon be more attractive opportunities in higher yielding debt, but here again it's better to stay liquid and stay out of the fray. As with long equity and short Treasury positions, patience is the overarching theme.
Commodities: Badly as equities have been hit, commodities have just been wrecked and are in free fall. The liquidation has been heavy and extensive. There might be some temptation to bargain hunt, but I would resist it. We could see quite a lot more downside before the markets settle down. Remember that unlike equities, which are long lived and often pay dividends, commodities by their nature are shorter term assets which often have carrying costs that amount to a negative yield. This can make exchange traded products less suitable for holding through a downturn. For these reasons investors should exercise caution.
Moving on to gold, which is a different matter altogether, we have a more constructive outlook. Gold saw a strong bounce on high volume Friday, bringing it up to the 50 day moving average after coming off a double bottom. While it's a bit early to sound the all clear, there is some strength here that is worth watching. A move above 1,675 would be very positive for gold.
Currencies: We saw the dollar index stall out at 83, but we also saw a similar action a couple of weeks ago at 81.50. That proved to be a short lived and shallow consolidation. What happens next is anyone's guess. The speculation is that the weak economic data would spur the Fed to further easing, which in turn would pressure the dollar. I am skeptical, particularly given the politically charged atmosphere ahead of the presidential election.
In the shorter term, we could see a more lasting correction or consolidation in the dollar that would likely bring a welcome respite to risk assets, but don't count on it. The news flow coming out of Europe is still trending negative; Friday's downgrade of Italy by ratings firm Eagan-Jones was yet another blow, following the ECB's rejection of the Spanish government's plan to recapitalize struggling lender Bankia. So long as it appears to be coming unraveled across the Atlantic, the dollar will continue to rise.