The third week of November in the financial markets continued the trend we have seen in play for quite some time now: Economic data pointing to an ongoing - if unsatisfying - recovery in the U.S., set against events pointing to continued debt trouble in Europe. Last week the worries outweighed the optimism. Let’s break down the numbers.
Stocks: U.S. equity markets were under pressure for most of the week, with selling pressure and volume accelerating on Wednesday and Thursday, finally leading into a relatively flat day on lighter volume Friday. The Dow Industrials dropped nearly 3% for the week, the Russell 2000 3.4%, and the NASDAQ and S&P 500 nearly 4%. The S&P, having failed repeatedly at the 200 day moving average over recent weeks, found support at the 50 day. The NASDAQ, however, broke below . Every S&P sector posted losses, the financials once again bringing up the rear with a fall of more than 5%. Joining them in the 5% loss column were the materials and energy, while the smallest losses were in the defensive consumer staples and utility sectors.
Global markets were not immune to the selling pressure, with every major index we follow closing in the red. The Euronext 100 fell 4.6%, the FTSE and TSX off more than 3%, and all four BRICs down between 2 and 5%.
Bonds: The return of Europe-inspired risk aversion again drove down Treasury yields. The benchmark 10 year fell below 2% for the third consecutive week, and for the third consecutive week closed just above that level. The 30 year however did end the week below the 3% level for the first time since the October 4th market reversal. The five remains under 1%. TIPs and corporate paper sold off as investors rotated into traditional Treasuries, while munis were relatively flat for the week.
Commodities: Commodity prices fell in most areas, driving the CRB index to a 2.5% loss. WTI crude briefly broke above the $100 mark during the middle of the week, but the market rejected that price level and we saw a sharp reversal, with a bearish engulfing on a candlestick chart, on Thursday, and a close below $98 on Friday. Two of the stronger commodities were lean hogs, which appear to be in a new uptrend going back to early September, and coffee, which looks like it is coming up off a triple bottom formed over the last seven weeks. Gold and silver were off again, their uptrends well and truly broken for the time being.
Currencies: As concerns in Europe continued, the U.S. Dollar Index advanced steadily through the week before pulling back slightly on Friday. Very short term resistance is at 78.5 on the index, with support at the 50 day, around 77.4. The euro is trending down, but remains above the $1.30 level that was breached at the beginning of October. Sterling and the Aussie and Canadian dollars are also in downtrends, while Yen has been rising and regained the 50 day in spite of BOJ efforts to drive it down.
The past week’s U.S. economic data continued to support the slow recovery outlook. Most of the headlines seemed to focus on the modest improvement in unemployment claims, and better than forecast building permits and housing starts. The latter in particular were encouraging, as the moribund housing market has been a real drag on the economy. Also sounding a more cautionary note were the CPI and PPI numbers, which suggested flat to falling prices, again raising the unwelcome specter of deflation. All of the data, however, was overshadowed by concerns about contagion from a financial crisis in Europe.
Stocks: The October rally has given way to a November correction. Q3 earnings were reasonably good, some full year forecasts have been cut but not alarmingly, and U.S. economic data, while not robust, certainly doesn’t point to another recession. However, the European debt crisis is weighing heavily. The problem here is that market participants can quantify the earnings and economic data to come up with some sort of valuation, but there is no reliable way to quantify the European financial contagion risk. Therefore it should come as no surprise that this uncertainty is a major headwind to a sustained advance in equity prices. We have been bullish on the prospects for U.S. equities based on the data, but have to pay attention to market signals. I have made the point before but it bears repeating: we have seen market cycles that shrug off bad news and buy the dips, and we have seen market cycles that shrug off good news and sell the rallies. The current phase looks to me like a case of the latter.
We have previously looked at the SPX and its failure to sustain a move above the now downward sloping 200 day moving average.
(click on all charts to enlarge)
We could also point out that the Dow Transports had done the same, failing to confirm the Industrials’ move above the 200 day, a level which the Industrials have since failed to hold.
Likewise the NASDAQ where, with leading stocks such as Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN) rolling over, and former darlings Netflix (NASDAQ:NFLX), Green Mountain Coffee (NASDAQ:GMCR) getting crushed, the index has punched below the 50 as well as the 200 day. Overall, it’s time to play defense on the equity side of the portfolio.
Bonds: We’re still seeing ample demand for U.S. Treasury paper with the 5 year note yielding less than 1%, the 10 year just over 2%, and the 30 year under 3%. It wasn’t so long ago that many of us expressed astonishment at those numbers, but now they hardly raise an eyebrow. Perhaps with the CPI and PPI numbers cited above, Treasury bulls like Gary Shilling and David Rosenberg might be vindicated, but for those of us managing portfolios to produce income for real people to pay real expenses, it’s a tough environment. We’re at zero allocation to U.S. Treasuries in our income portfolio, which means taking on a bit more risk than we would normally like, and having to manage it more actively. Some of our current positions are on a short leash, especially our lower grade paper, but we’re happiest with our closed end muni funds.
Commodities: In this series of articles we have recently held a generally positive outlook on commodities. Strength in the U.S. dollar and a failure of oil prices at a breakout point has turned that outlook negative in the short term. In recent trading we have seen the CRB index fail to punch through the upper bound of the trend channel, and Friday’s action saw the index undercut the low of November 1st, a negative technical signal. We’re on hold in terms of adding commodity positions to our total return portfolio.
Currencies: The U.S. dollar, as I have so often commented, is really a key indicator for all the financial markets. After making a big move in September, the dollar index pulled back through October but made a higher low, and has renewed its advance in November – an advance that coincides with the stalling of the equity rally and further pressure on commodity prices. Look for the dollar to make another run at the 80 level. If the index breaks through that level we should expect more weakness in risk asset prices, but a failure would be constructive for equities and commodities. Again, what happens in Europe will be decisive. A move in the euro to $1.30 or below would be troubling.
Disclosure: I am long HYG.