Asset Class Movements: So Much for the Summer Doldrums

The shifts in relative asset class performance over the past month have been remarkable. The most dramatic movements have been in the commodity sector, where oil prices have dropped $35 (or 23%), gold prices have plunged $200 (or 19%), and the diversified Dow Jones-AIG commodity index has sunk 17%.  These sharp moves have occurred alongside a 7.5% rally in the U.S. dollar index. 

In equity markets, the rotations have also been dramatic.  Whereas U.S. stocks have enjoyed nice rallies off the mid-July lows, with the S&P 500 gaining 7.5% and the small-cap Russell 2000 index jumping 14%, foreign stock indexes have slid to new 52-week lows.  Emerging markets stocks, the equity asset class of choice in recent years, is down 21% in 2008, versus a 10.5% loss in the S&P 500.  Relative to foreign stocks (both developed and emerging markets), the S&P 500 is now trading at its highest level in a year. 

 

Within the U.S. stock market, the most heavily shorted sectors have seen the sharpest gains since the lows of a month ago.  Bank indexes have rallied over 40% from their panic lows, and indexes of consumer discretionary stocks have jumped 17%, aided by the correction in energy prices.  

What is driving these asset class shifts?  None of the fundamental explanations that have been put forth in the financial media regarding the relative outlook for U.S. economic growth and monetary policy versus that of foreign economies carry as much weight as the simple explanation that the multi-trillion dollar global leveraged speculating community (read: hedge funds) got caught overcommitted to a set of positions - e.g. long commodities, short the U.S. dollar; long energy stocks, short financials and retailers, etc. 

Particularly in markets like gold, which plunged $70 last week alone, dramatic price moves are more indicative of liquidations on the part of leveraged market participants and self-reinforcing momentum than altered fundamentals.  The medium to longer-term fundamentals for gold as a store of value and a refuge from paper currency debasement remain very positive, and it must be kept in mind that despite the recent rout, gold is still up 19.6% over the past year and 16.7% per annum over the past five years.  In the short term, gold will remain very volatile and could have further downside, but we anticipate that an important low will be in place in the gold sector by the end of the month and that from a longer term perspective, purchases in the $800/ounce range will be well rewarded.

Turning back to the stock market, it is still too early have conviction that a major low was reached in mid-July.  It remains to be seen whether U.S. stocks will remain firm if commodities stop falling and the U.S. dollar stops rising.  The fact that foreign stock indexes have moved to new 52-week lows does not bode well for the near term prospects of the global economy.  Moreover, the bounce in U.S. stocks has occurred alongside a widening of credit spreads, so equity and credit markets are sending mixed signals regarding the economic outlook. 

Finally, we have still not seen any upturn in the leading economic indicators we track from the Economic Cycle Research Institute [ECRI].  In fact, ECRI's gauge of future U.S. economic growth recently fell to its lowest level in more than five years, indicating the business cycle is not poised to recover in the near term.

Comments

[ETF Wanderer_:]

ECRI is as junk as it can get.

2008 Aug 18 11:12 AM