With the third quarter now in the books, it's time to take stock of where we have been, and look ahead to Q4. Let's get right into it:
Stocks: U.S. equities did not see any window dressing as the market closed out a strong Q3. All of the major indexes were down for the week, but booked solid gains for the quarter. The Dow Industrials and S&P 500 shed a little over 1% on the week, but gained 6.6% and 8.4%, respectively, over the quarter. The NASDAQ and Russell 2000 each dropped more than 2% on the week, finishing with gains of better than 9% on the composite and nearly 8% for the small caps. The Dow Transports and Utilities on the other had a decidedly less robust quarter; the Transports were off more than 6%, while the Utilities dropped 1% - but fell more than 3% over the last two months.
Turning to the nine major S&P sectors, only the utilities closed out the quarter with a weekly gain, while tech slumped into the close on big drops in Apple (AAPL), Microsoft (MSFT) and the semiconductor stocks; the sector as a whole dropped more than 2%. For the quarter, tech was up nearly 6%, second only to the 7.6% gain recorded by the energy sector. The only sector to book a quarterly loss was the aforementioned utilities.
In global markets, nine of our 12 major foreign indexes were in the red for the week. The winners were The Bombay Sensex 30, the Shanghai Composite, and the Hang Seng Index. Over the entire quarter, Shanghai was by far the weakest, but managed to hold above the 2,000 level. In the final week, Brazil's Bovespa and Japan's Nikkei broke down through their 200 day moving averages.
Bonds: U.S. bonds ended the quarter on strength, with the benchmark 10-year Treasury note closing to yield well under 1.7%. The long bond closed at 2.85% - back under the 200-day MA - while the five-year note closed to yield 63 basis points. The Dow Jones corporate bond price index ended the quarter at yet another new high. Municipal bonds also ended near highs, but junk corporates pulled back from tops in the final weeks of the quarter. In a quarter during which we saw much scorn heaped on U.S. Treasuries, the popular iShares long term fund (TLT) was off less than 1%, and was nearly flat on a total return basis.
Commodities: After a giving back the big QE3 pop the prior week, the CRB commodity index came back to re-test the 200 day-MA and held last week, putting the wraps on a nearly 9% quarterly gain. WTI crude oil dipped back into the upper $80s before closing just above $92. Gold recorded a second consecutive flat week, and seems to have stalled under $1,800 for the time being. Silver likewise appears stalled under $35. Copper pulled back from resistance at $3.80. The grains continued to pull back from their drought-fueled rallies. Sugar and coffee look like they are continue to work on putting in bottoms.
Currencies: The U.S. dollar index, coming off support, tested the key 80 level on the last three days of the month, but failed to close above it each time. The euro pulled back to the mid $1.28s and traded in a tight range around that level. The Swiss Franc closed right on its 200-day MA. Sterling ended the quarter off its recent highs, but remains above $1.60. The Aussie and Canadian dollars also closed off their highs, but both remain above parity against the greenback.
The final weeks of the quarter brought renewed concerns about growth in the U.S. economy, as well as the stability of the eurozone. Q2 GDP was revised down to 1.3%. Chicago PMI came in below 50 for the first time in three years, completing the "trifecta" with the very poor flash PMIs we saw from China and Europe in recent weeks. Durable goods orders were well short of expectations with a -13% print. Personal income and spending were nearly flat. On the housing front, new home sales reported by the Census Bureau came in under expectations, even as the Case-Shiller 20 city index beat them.
As we look ahead to Q3 several questions hang over the markets:
- Will earnings come in as weak as some of the guidance we have been getting ahead of quarter end, or will they beat lowered expectations?
- What impact will the U.S. election outcome have on the markets, and how will the Congress handle the approaching "fiscal cliff?"
- What will happen with Greece, and more importantly, Spain?
Stocks: U.S. equities have enjoyed another strong quarter, and to date, another solid year. There is some debate about whether the gains are "real" or some kind of false rally induced by monetary policy. To me this is at best an academic debate. The market data speaks for itself…and the market has been acting pretty well, thank you very much. Even with all of the worries outlined above, and certainly there are a good many more, the market continues to make new highs, and remains in an uptrend. Until the trend breaks, and we fail to see new highs after pull backs, I see no reason to change course.
I do however see plenty of reason to extra close pay attention in the coming weeks - see the questions above. I have previously mentioned some unease about the divergence between the transports and the broad markets. The economic data is confirming the weaker outlook there. We are also seeing pronounced weakness in the tech and small cap sectors, which should sound a note of caution. At this point I am looking for the S&P 500 to hold above 1,400. A break below that level would turn my outlook decidedly more cautious. Bellwether Apple is near short-term support at $660; if it breaks we could see $600 tested, which would be a significant drag on several of the indexes.
Finally, I would like to share a note on one of our long-term holdings, Microsoft (MSFT). Many of the stocks associated with the hardware side of the PC business had a very tough Q3, but Microsoft stayed above the $30 share price and 200-day MA for much of the quarter. However it broke both levels on the final day, and recent selling has been on elevated volume. This is not a good sign just ahead of the release of Windows 8, the software giant's latest push for relevance in the mobile space. If the stock does not see a bounce in short order, I will be a seller.
Bonds: As detailed above, for all the hand wringing over the bond market, Q3 just wasn't that bad. The weakening economic outlook should make bond investors more sanguine, at least in the short term. With yields having pulled back from the September highs, I would not be buying duration just yet, but a return toward the levels of mid-August and mid-September would be a better entry point for investors looking to put money to work in fixed income. In high yield bonds, we have already seen a correction that has made for a slightly more attractive entry point. Just be careful to allow the correction to run its course before committing capital.
Commodities: With respect to commodities, to this point it looks a bit like buying the QE rumor and selling the news may have been the right strategy. However it is still too early to tell. We have seen strong runs in the grains and the precious metals, but oil has been weaker. If gold is unable to get through $1,800 or silver through $35, we are likely to see weakness going into year end. Of course we will need to watch the U.S. dollar in this context. Oil has been unable to generate much upside momentum since July. One area that has shown consistent strength is natural gas, which has made a series of higher highs and higher lows since coming off the April bottom under $2. Gas gained more than 14% last week to close at a new year to date high.
Currencies: The U.S. dollar index is at a key resistance level as we move into Q4. If short-term upside momentum in the dollar continues, we could see this level broken relatively quickly. A rising dollar, combined with a weakening global economic outlook and deteriorating fiscal condition in Spain could see a rotation back into the risk off trade. We need to watch developments here carefully.