Election week in the U.S. was a happy one for some, not so happy for others, and difficult for many investors. The morning after the election, while post-mortems were being written on the campaigns, stocks sold off heavily. What now? Let's see if the numbers hold any insights.
Stocks: Ahead of the election, trading was light and showed a little upside bias, but investors were largely on the sidelines. Wednesday opened with a sharp move down, and gave us a 2% down day on the heaviest volume in nearly two months. Thursday brought another move to the downside. By Friday, the selling seemed to have exhausted itself in the short term. By the closing bell, all of the major U.S. equity indexes were off more than 2% on the week, and all had broken their 200 day moving averages. The S&P 500 closed below 1,400, the Dow Industrials below 13,000, the NASDAQ below 3,000, and the Russell 2000 below 800.
Breaking down the S&P sectors, there was no place to hide from the selling pressure. Dividend stocks, the clear darlings of 2012, took the worst of it: the utilities dropped nearly 5%, the telecoms more than 3.5%. Even the least affected sectors fell more than 1%
Global markets, which have recently begun to outperform the U.S., held up better. Both Morgan Stanley's developed and emerging market indexes, and all twelve major foreign county indexes we follow, took weekly losses. However, the two broad Morgan Stanley indexes remain above their 200 day moving averages, and several of the single country indexes posted only modest corrections after recent gains.
Bonds: U.S. treasury bonds were bid up sharply in a clear bout of risk aversion. The long bond closed to yield under 2.8%, while the ten year note was closed at just over 1.6%, and the five year fell under 64 basis points. Corporate bond yields again were little changed over the week, but lower grades sold off as the yield spread on junk widened from extremely low levels. Municipal bonds caught a nice bid, no doubt in anticipation of higher tax rates to come; a number of muni funds went to new highs after consolidating over the past several weeks. TIPS were also big higher.
Commodities: Commodities trading was very choppy; the S&P-GSCI commodity index, which has been grinding lower for nearly two months, bounced ahead of election day. It joined in the selloff the day after, then fought back the rest of the week, holding support at the 630 level. Oil repeatedly tested $84 - successfully - and ended the week at just under $86. Natural gas slipped again, closing just above $3.50. Gold on the other hand was bid higher amid the risk aversion, and tested the 50 day moving average on Friday, finally closing at $1,730. Silver also enjoyed a bounce off the 200 day. Copper slipped further, as did the grains and the softs.
Currencies: The U.S. dollar index moved above its 200 day moving average, climbing above 81, while the euro gave up its 200 day and fell back to just over $1.27. Most of the other major currencies sold lower against the greenback, but the major exception was the Japanese Yen, which advanced more than 1% on the week.
Of course the big news was the outcome of the election, which essentially preserved the status quo, and attention immediately shifted to the impending "fiscal cliff." Actual economic data releases were very light, the most notable being the upside Michigan consumer sentiment survey. Earnings news brought another high profile revenue miss from media giant Disney (NYSE:DIS), as well as misses from smaller firms such as Groupon (NASDAQ:GRPN) and JC Penney (NYSE:JCP), but positive reports from others such as Qualcomm (NASDAQ:QCOM).
Stocks: Equity investors seemed to be more focused on the negatives than the positives. We just mentioned the positive earnings report from Qualcomm. The after hours release was followed the next morning by a gap up in the share price - but the stock sold lower through the day. It goes to demonstrate the risk aversion that gripped the market. Another clear indicator of the risk off sentiment: gold and Treasury bond prices moved up together.
After looking for the market to make a stand for the last couple of weeks, we have seen the major averages, and a number of blue chips, break down. The SPX has retraced nearly 50% of the move from the June low to the September high. The market now has to show us that it can stop the slide. In the short term, I am looking for the 200 day lines to be tested from beneath, as well as the aforementioned "round number" levels of 1,400 on the S&P 500, 13,000 on the Dow Industrials and 3,000 on the NASDAQ. Note that the May correction pushed the SPX below the 200 day SMA for a couple of days, but that marked the low, and was a buy signal, not a sell signal. If the indexes can retake and hold those levels, to me it would signal a green light to step in and take long positions. Failures at those levels, on the other hand would signal a higher probability of further downside, and I would further trim longs.
Finally, as I have noted in the last couple of articles, investors should be looking at overseas markets. The relative performance, particularly in larger established firms in emerging markets, is showing signs of becoming a trend. As investors, we always have to go with what is working, and currently, emerging market stocks are working. A broad and prolonged equity pullback would probably bring them down as well, but there is some positive momentum going on there.
Bonds: Last week's trading action took U.S. Treasury yields back down to the low end of their recent ranges. As noted above, we saw different bond market sectors move in different directions. To me there are mixed signals here: Treasuries signaling risk aversion, TIPS signaling inflation worries, munis anticipating tax rate changes, junk bonds pricing in increased default risk, and investment grade just seeming too expensive. The bond market in general just seems a bit of a mess, and it's difficult to find much to like at current prices. Our income portfolio, as I have been disclosing for months, is heavily allocated to corporates and munis, and we still like what we already hold, but aren't buying any more.
I have written in recent weeks that we have been looking at utility stocks for income generation, and waiting for the selloff in that sector to run its course. The same post-election tax concerns that priced muni bonds higher have taken utility shares and certain other dividend stocks sharply lower. At some point, probably sooner rather than later, I can see us rotating from out of some our fixed income positions and into equity income. For income investors capital preservation is paramount, so buying after a major pullback lessens downside principal risk. I understand risk and monitor it constantly. This point cannot be emphasized enough for income investors who move down the balance sheet.
Commodities: The commodity last week was interesting. Commodities sold off ahead of equities, and the losses have been deeper. Last week we saw buyers come into the market in some areas. Of particular interest was the advance in gold while the U.S. dollar was rising. This is a trend that seems unlikely to continue, but whether it is gold or the dollar that continues to advance is an open question. In the short term, look for gold to take another run at the 50 day SMA. We maintain a long position in gold. Oil appears to have found near term support; we could see it continue to trade sideways, but another move toward $90 or a break below $84 could signal more directional trading. The dollar should play a part there as well.
Currencies: With the dollar index making a tentative upside breakout, the markets are coming under some pressure. The ongoing troubles in Europe have certainly played a part. The concerns about a U.S. "fiscal cliff" have brought plenty of commentary, but the action in the currencies is instructive here. The market appears to expect a satisfactory resolution that avoids significant economic damage. The dollar remains the best house in a bad neighborhood and, with nothing really resolved in Europe and France now coming under the microscope,it looks to remain so.
The implications of dollar strength are something I periodically bring to readers' attention. It has mostly been correlated with the "risk off" position since the crisis. However at some point this market phase will change.