Week in Review
Let’s take a quick look back at a week in which the macro picture was dominated by two big stories. One of these was the Irish debt situation and the moves toward a tentative resolution plan to be published Tuesday. The other was China’s fifth increase in bank reserve requirements, along with a warning that price controls might be imposed, in an effort to control inflation. In the markets, we noted in our midweek update that there was much action taking place at the 50 day simple moving averages in a number of asset classes and indexes.
Stocks: The week saw little change in the SPX, Dow Industrials, EAFE or European 100 indexes. Small caps were a little stronger in the US, while emerging markets showed the most weakness, due largely to 3% drops in the Shanghai Composite and India Nifty Fifty indexes. Japanese stocks gained on continued Yen weakness. Drilling down in the US market, industrials were the leading S&P sector while financials lagged. Along with the small cap outperformance, this gives us a fairly clear indication that financial system worries, not growth concerns, were the key driver of the week’s sector rotation.
Bonds: Once again Treasury yields rose across the curve from 3 month to 10 year maturities, with the 30 year yield falling back slightly. The long bond price came near its 200 day moving average before bouncing in the latter part of the week, and settled with a 4.25% yield. Corporate bonds, TIPs, and municipals fell again, though the munis rallied in the latter part of the week after what can only be described as an unusually severe decline. The explanations most commonly heard were concerns over state and local government finances, along with the impending expiration of stimulus funding, but even that doesn’t seem to explain the type of action we saw. Something more is going on here, and we need to see what develops.
Commodities: The CRB Index pulled back again, with oil and grains both off more than 3%. Natural gas displayed both its volatility and its often contrary nature, gaining 10% on the week. In the precious metals, silver and palladium rose while gold and platinum fell, while over on the industrial side, copper futures fell for a second consecutive week.
Currencies: In a week dominated by the eurozone and China, the US Dollar index gained a little more after the prior week’s strong bounce. The euro recovered late in the week to finish with a slight loss, while Sterling, Yen, Swiss Franc and Canadian Dollar indexes all retreated. The commodity linked Aussie Dollar finished nearly even on the week.
Trading Themes, Week of Nov. 22 - 26
Stocks: We have now seen a week of reversal and a week of sideways consolidation following a 10 week run to a new yearly high. Perfectly normal action and right in line with what we might expect to see in a healthy stock market. The daily chart of the SPX below gives us a nice visual picture, and we’ll note some of the highlights here rather than annotating the chart itself as is our custom. Note that some different indicators are used to bring out a clearer picture of the index.
1. Bollinger bands have contracted since the summer as volatility decreased. We could also have seen this by plotting a chart of the VIX but it’s right here on the SPX chart. This tells us there was some profit taking at the new high, but not much more than that.
2. Note that the 50 day SMA is roughly parallel to the lower band; the price plot approached this lower boundary and moved back up, again suggesting that there was no severe selloff, just some profit taking.
3. The volume bars show slow accumulation taking place, as we see a series of taller dark bars followed by shorter red bars going back to June. There is good volume on up days and not a great deal of heavy selling pressure following.
4. Money flow is shown beneath the price plot, and shows that there is continued buying to support the index.
(click on charts to enlarge)
My takeaway from this: we could see continued consolidation, and we should expect light trading on a short holiday week, but the overall picture still leans to the bullish side. We just went through another euro zone scare and the US equity markets simply shrugged it off for the most part. Market internals look healthy.
Bonds: Once again, not much new to say about bonds. Yields continue to rise, and eventually the investors who have piled into this asset class will notice they are sitting on unrealized capital losses. We have already seen net redemptions in muni funds, where the damage has been most severe, from the ICI data. We should note, however, that the long bond did find support at the 200 day SMA, as shown on the chart below. Still, my overall stance on bonds continues to be bearish.
Commodities: The CRB index, as shown on the chart below, came back to the 50 day SMA where it found near term support. Uptrends in a number of commodities remain intact. However oil remains in a long running trading range, and as the US Dollar firms up, its prospects for a bullish run continue to be less than compelling. Regular readers know I have not been an oil or natural gas bull, even though I hold long equity positions in a number of large energy companies. Those are long term holdings in what I see as companies with compelling valuations and strong ability to generate future cash flows, but trading crude oil shows little upside potential at this point.
Currencies: One of the consistent forecasts made on this blog over recent months is that the US Dollar index would not break the 76 level, and to this point that remains the case. As shown on the chart below, in its volatile swings over the last three years the index has put in a series of higher bottoms. Also note that the index briefly came up to a point just below 80 where it had seen support on a number of previous occasions, before closing just above the 50 day (10 week) SMA. Rising Treasury yields and a slowly but surely growing US economy are generally going to be supportive of the Dollar, which may have been oversold ahead of this month’s FOMC meeting. Dollar strength could have some impact on risk assets, so this continues to be an area we need to watch closely.
In summary, we have an interesting situation where the broad equity, commodity and US Dollar indexes are all above their 50 day moving averages. Of course, the stock and commodity moving average lines are upward sloping while the Dollar’s is downward sloping, as the former are in primary uptrends while the latter is in a primary downtrend. However this is worth noting as the correlations between the US Dollar and other asset classes has been shown to be significant. My read for the coming week is generally bullish on stocks, bearish on bonds, and neutral on commodities, but no strong conviction trades.
Good luck, good trading, and a Happy Thanksgiving to all
Disclosure: Author is long a variety of equities and municipal bonds and short Treasury bonds in various portfolios