Investors, who in recent years have become accustomed to parsing the words and deeds of central bankers, looked to the heads of the Federal Reserve and European Central Bank for some good news last week. None was forthcoming and yet, rather than throwing a tantrum, the markets threw a little party instead. Just when we might have thought they were getting to be predictable, the markets reminded us again that they do as they please. Let's look at some numbers.
Stocks: The market was slumping along through the middle of the week and on its way to breaking a three week stretch of gains on the Dow and SPX, but a healthy bid came in on Friday to extend the blue chip winning streak. While Friday's enthusiasm extended to small caps as well, it was not enough to pull the Russell 2000 up to a weekly gain; in contrast to the blue chip rally, the small cap index has now lost ground in three of the last four weeks. Volume was typically on the light side, as we would expect for a summer Friday.
Drilling down into the S&P Sectors, the previously lagging techs led the way with a gain of 1.5%, while the stronger utilities and health care stocks gave back some of their recent gains. The dispersion across sectors however was not particularly great, with six of the nine groups moving less than 0.5% on the week.
Ten of the twelve major foreign indexes we follow posted weekly gains, the exceptions being Tokyo's Nikkei and Toronto's TSX Composite. The largest gains were generally seen in Europe, where the larger markets have generally kept pace with the U.S. since the May correction, in spite of the tenuous economic situation.
Bonds: Treasury yields rose for a second week, with the five, ten and thirty year bond yields all closing just above their 50 day moving averages. Corporate yields on the other hand did not follow Treasuries to the upside, but the exaggerated drop we have been seeing since June appears to have stabilized, and the Dow Jones corporate bond price index is beginning to look like it may be putting in a top. Municipal bonds are also looking toppy, as fiscal concerns may finally be starting to weigh on the extended muni market.
Commodities: Friday's risk on move, and the slump in the dollar, pushed oil back above $90, for a one day gain of nearly 4.6%. Gold made a more modest move, but notably bounced off the 50 day MA and closed above $1,600. This should be encouraging for gold bugs, as the metal has been trading beneath the 50 day for most of the time since early March, and has had trouble holding $1,600 since May. We'll see what happens from here, and certainly much will depend on the course of the dollar. Copper came off support at $3.30, while the grains appear to have stabilized, albeit at high prices and with little relief in sight for consumers.
Currencies: After holding support at the 50 day through the entire week, the U.S. dollar index broke down Friday, with a pullback of nearly 1.2% on the session. The euro rose to nearly $1.24, its highest level since early July. The slumping British pound cam e off support at $1.55 as the dollar weakened, and the Aussie and Canadian dollars extended their rallies. Yen was little changed ahead of next week's BOJ policy meeting.
There was little to inspire confidence in last week's economic or earnings reports, but the market seemed to want to advance anyway. The much commented nonfarm payrolls number, which surprised to the upside, was nothing to celebrate in absolute terms, and the unemployment rate actually ticked higher, while the often overlooked average hourly work week did not budge from the anemic 34.5 hours reported previously. The July ISM index came in under 50, and June factory orders printed negative. Amid all of this, data there was no new Bernanke put coming out of the FOMC, and the much anticipated ECB meeting brought precious little in terms of specifics after Draghi's bold "whatever it takes" pronouncement the prior week.
Earnings were a little more of a mixed bag as Q2 reporting season winds down. Several blue chip consumer staples and health care firms reported positive results, but financials and industrials had little good news for investors, as the European recession began to be reflected in the operating results. Going into the latter part of the year, the outlook for growth continues to be soft, though it still appears the U.S. may avoid falling back into recession.
Stocks: There is a distinct rotation taking place in the domestic equity markets. I have previously noted that the small caps led the rally off the Q4 2011 to Q1 2012 rally, but have since lagged. This trend is continuing as the market recovers from the May correction. The large caps are in distinctly better shape: as of Friday's close, nearly two thirds of the S&P 500 are trading above their 200 day moving averages, while three out of four are above the 50 day. At this point the market reads neither oversold nor overbought in the short term, but it could be vulnerable to a pullback - the NYSE summation index has been rolling over since the last week of July, indicating that fewer stocks are participating in the advance.
The S&P 500 is continuing to make higher highs and higher lows, and I do think the trend is your friend, but stay alert here. I had been anticipating another leg down in the markets, and have been pleasantly surprised by the summer rally. A re-test of the April high looks likely at this point, which is only 2% up from Friday's close on the SPX. How the market behaves at that point should give us a pretty good idea how to approach the rest of the year. A new 52 week high would be quite bullish, but a failure to get through 1,420 on the SPX would be troubling. My gut tells me we will not see a new high this summer, but we'll let the market speak for itself.
Bonds: The bond market, as described above, is showing signs of working off some of the excess built up over the last three months. My suspicion is we will not see 2% on the ten year note or 3% on the long bond before the year is out, but we should get close. That still would not turn me into a buyer of Treasuries, but I would look at a general selloff in the bond market as a buying opportunity in corporate issues for our income portfolio, which should continue to be attractive going forward. As for municipal bonds, which we hold in both portfolios, I continue to be comfortable holding, but am not committing any new money.
Commodities: The rise in crude oil might have been attributed to the surprisingly large inventory draw down, but the two day lag between the data release and the price pop, that explanation seems suspect. It could just as well have been a short squeeze, but in either case it's difficult to see a price above $90 given demand softness as sustainable. Meanwhile we saw a significant correction in natural gas, which is into the fourth month of a rally off the bottom. I don't see either as a particularly compelling buy at this point. Gold has found support, as described above, but seems range bound, waiting for a catalyst to signal a move higher or lower. The grains are pausing after a tremendous sprint higher, but given the crop data, we are likely to see another leg up. Copper and the industrial metals aren't showing much in the way of price momentum. Overall, apart from the grains, there isn't much to like here, but with the Jackson Hole symposium coming at the end of the month - the market remembers August of 2010 - that could change.
Currencies: The market appears to have started discounting events that have yet to actually happen - another expansion of the Fed's balance sheet, and a real solution for Europe. Apart from this faith based exercise in selling the dollar and buying euros, it is difficult to see actual evidence of a catalyst for the action we saw last week. With the aforementioned Jackson Hole symposium just weeks away, perhaps some traders are positioning ahead of the news. In any event, with near term support broken, we could see a move toward 81 on the dollar index, which should help to extend the risk asset rallies for a while longer. Jackson Hole could be a game changer once again, but on a fundamental basis, the U.S. economy and the dollar continue to look like the dogs with the fewest fleas. I expect dollar weakness to be short lived, and would be very surprised to see the index dip back into the 70s as we head toward the latter part of the year.