The financial markets took what looked like a potential turn last week, as we saw some unusual inter-market correlations emerge: gold and Treasury bond prices rose at the same time, while stocks and the U.S. dollar fell together. Was it a temporary "blip on the radar" or the start of a larger turn in the markets? Time will tell, but let's look into the details.
Stocks: After a summer rally which saw U.S. equities post gains in nine of the previous eleven weeks, and new post-crash highs on the S&P 500 and NASDAQ 100, the market took a bit of a breather last week. Even with Friday's bounce, all of the major indexes posted modest losses for the week, ranging from less than 0.1% on the NDX to 1.3% on the Russell 2000. Outside the major indexes, the Dow Transports and Dow Utilities saw losses even greater than the small caps.
S&P sector action was negative nearly across the board; only the health care sector managed to put up a gain. The other sector to avoid a finish in the red, the financials, recorded a move of exactly 0%. The tech sector was unable to record a gain even as Apple attained the largest market capitalization in history. Apart from the aforementioned losses in the utilities, losses in the 1% or greater range were seen in the industrials and in materials. It was also a tough week for leading telecom stocks.
Taking a global view, equity weakness was widespread; ten of our twelve major foreign indexes were down for the week. The winners were Russia, thanks no doubt to the nation's admission into the World Trade Organization, and India, where the Sensex 30 recorded its fourth consecutive weekly gain. The Shanghai Composite broke to another new low, closing below 2,100.
Bonds: Treasury yields snapped a four week run up with a sharp drop. The five year note closed with a yield just over 70 basis points, the ten year under 1.7%, and the thirty year bond under 2.8%. Notable from a technical perspective, all three had risen to just under their respective 200 day moving averages before pulling back. The falling yields ended, at least briefly, a correction in bond prices across most sectors. The popular iShares investment grade fund (LQD), often seen as a proxy for the corporate bond market, gained more than 1.2% on the week, while the iShares TIPS fund (TIP) gained nearly 1.3% - an impressive move for a bond fund.
Commodities: The CRB commodity index enjoyed its eighth weekly gain in the last nine. WTI crude oil breached the 200 day MA, but could not hold it; after trading up to more than $98, it closed the week just above $96. Natural gas began the week by taking back some of its recent losses, but gave back the entire week of gains on Friday, as the spot price dropped nearly 4.6%. Gold had a positive week, closing above the 200 day for the first time since March. Silver, platinum, and palladium also eclipsed their 200 day marks as there was a strong bid for precious metals. Copper and the industrial metals also recorded gains, albeit much more modest. The grains were more of a mixed bag; corn reached another new closing high Tuesday, but erased most of the week's gains by Friday. Wheat saw a similar trading pattern, but remains well above $8.50.
Currencies: The U.S. dollar index saw renewed weakness after nearly two weeks of trying unsuccessfully to get through the 50 day MA, and re-tested the June lows near 81 before firming somewhat. The euro was bid above $1.25, as European leaders expressed what was interpreted as a commitment to keep Greece in the EU. The Yen and Pound Sterling also rose against the dollar, as did the effectively euro-pegged Swiss Franc, but the Aussie and Canadian dollars pulled back against their U.S. counterpart.
It was another light week for economic and earnings data. Unemployment claims continued a trend of coming in higher than expected, as the employment outlook remains soft. New home sales beat forecast but existing home sales fell short. Durable goods orders ex-transport saw a negative print. Perhaps most widely noted, the July FOMC minutes seemed to suggest that the Fed is preparing to extend its efforts to support the economy - PIMCO's Bill Gross expressed a view that more easing is "a done deal." The news would appear to have contributed the moves in the dollar and in gold and precious metals, and increases the attention to the coming week's Jackson Hole symposium.
Earnings news was dominated by weak outlooks from the PC sector, as both Dell and HP disappointed investors. Though both bottom lines beat analysts' estimates, their revenues and full year outlooks were much less upbeat, and both stocks sold off heavily.
Stocks: The action in the market last week may not have been particularly notable from a fundamental perspective, in fact it was the type of week traders might expect during the dog days of late summer, but it was rather interesting from a technical perspective. After Tuesday's trading, I wrote an instablog post before the Wednesday opening bell that detailed my take on the action, so I won't repeat myself here. While I had been expressing a view that the market was due for a near term correction, and therefore was not surprised, there are a few salient features that I would like to bring to readers' attention here. At this point I am looking for a re-test of the 50 and/or 200 day moving averages. A successful test especially of the 200 day would give me the green light to add to long positions, and a close at a new high would confirm that bullish outlook.
Having stated the baseline scenario, here is the other side of the picture: a failure to hold the 200 day would be quite concerning and would keep me on hold. I am also a bit troubled by the non-confirmations among the major indexes, which I attribute in large part to the "Apple effect." Apart from the SPX, the other major index which reached a new high, the NDX 100, is also one in which Apple, which last week attained the largest market capitalization in history, has an even more outsize effect. The Dow Industrials, NASDAQ Composite (which does contain Apple but in smaller proportion), and Russell 2000 have all failed to eclipse their April highs, which is a bit disconcerting. The Dow transports are threatening to break down, and the Dow utilities already have. Those who see that market cap record as a contrarian signal may be entirely superstitious, and we shouldn't overstate the case, but quite a lot is riding on Apple, and any hiccup for that market bellwether could signal trouble for the market as a whole.
My overall outlook is this: the market continues to act well enough, and the Fed symposium next week may throw the old dog a fresh bone, but the rising tide is not floating all boats. Note that while 70% of the S&P 500 beat earnings estimates last quarter, nearly half missed on revenue. I still think investors need to be selective, and that holding indexes will be an underperforming strategy. Our total return portfolio is still weighted toward selected tech, health care and consumer staples companies, and we're still looking for best of breed companies in a variety of industries. In an economy where some firms are doing quite well, but many others are not faring so very well at all, careful stock selection should serve investors nicely.
Bonds: The overdue bond market correction appears to have run its course in the short term, and my assertion that we would not see yields on the ten and thirty year T-bonds get to 2% and 3% respectively, had held true - at least for now. With economic growth still on the weak side, and fiscal policy (which matters much more to the bond market than the Fed's monetary policy) moribund, there don't seem to be any catalysts for big moves in the bond market in the near term. Our strategy for the income portfolio remains steady: corporate bonds in a variety of grades, levered muni funds to take advantage of cheap and plentiful short term funding, and maybe a smattering of utility stocks now that they have corrected substantially. Unlike many income investors, I still think it's much too early to worry about inflation.
Commodities: The revelation of Fed Chairman Bernanke's letter to Congressman Issa was welcomed by the commodity market, which is looking for a repeat of 2010. My suspicion is that there has been a good bit of front running, and much of any new QE program may already be priced into the market. The CRB commodity index has broken both its 200 day moving average, and its 15 month down trend since the April 2011 top, which culminated the rally that began after the August 2010 symposium at Jackson Hole.
Unlike the broader index, WTI crude has stalled at the 200 day and the 62% retracement of the move down from the May high, and with the dubious prospect of an Israeli strike on Iran fading from view, the fundamentals should take over. Look for lower oil prices ahead, barring any geopolitical excitement. Gold on the other hand did break the 200 day and is threatening to break its own one year down trend. "Dr. Copper," meanwhile, is still bouncing around in the $3.30 - 3.50 range, and the grains are still moving sideways after the huge June - July run up. It seems to me the long side commodity trade is in the books, and there is more risk than potential reward to entering at this point.
Currencies: The U.S. dollar index also felt the effect of QE anticipation, and fell to a key support level. This is another market that will have its attention diverted to Jackson Hole, not only to parse the comments of the Fed Chairman, but the even more eagerly anticipated speech to be given by ECB President Mario Draghi. Central bankers have moved the financial markets for years, but the effect has been more pronounced since the crisis. At this point anything is possible, so stay tuned and alert. This week could be a game changer - but my suspicion is that the market may be underwhelmed.