Last week began the year of the Tiger in the Chinese calendar. Then on Friday, Tiger apologized. While China took the week off to celebrate, many on Wall Street actually stopped trading to watch the mea culpa of a golfer – a very good golfer, but a golfer. Once finished, trading resumed and the markets went on to finish the week on a high note. From an economic perspective, the markets are keeping an eye on foreign debt issues (they seemed to dissipate this week), economic growth here (modest) and interest rates (discount rate hiked). While much was made about the discount rate hike, it pertains only to the money lent to banks and does not (yet) affect rates charged via loans from banks. In what may be just a shot across the bow just to see how the financial markets might react to a pulling back from near zero interest rates, a passing grade has been earned so far. Bernanke will be explaining the actions of the Fed many times over this week as he is scheduled to speak in front of Congress three times (snow day make-up) to address whether more stimulus is needed and the usual semi-annual reports to both houses. Are you getting ready to head south for some springtime baseball? Don’t forget to put a tiger in your tank!
Eight consecutive days the markets have shown an upward bias, however many of our short-term indicators are not even close to overbought territory where a decline would likely begin. After passing the modest increase in the discount rate test and stronger commodity prices, the markets are looking like they want to go higher. Net advancing issues have yet to make a new high, although they are climbing, net advancing volume is singing the same tune. Overall volume continues to be very weak, with Thursday’s composite volume the lowest of the year. Intra-day moves of the markets are interesting, as the first hour of trading has been relatively weak, while the last hour has been relatively quiet. The first hour of trading tends to be rather knee-jerk based upon either overnight news or economic data releases that gets acted upon without much thought. The last hour is typically devoid of “public” activity as traders set themselves up for the next day. The indicator looks at the first hour as a negative and last hour as a positive. The accumulation of the data is supposed to show whether the “smart money” is buying or selling. Since April of ’09 the “smart money” has been selling and more aggressively since October ’09. This indicator foreshadowed the rally of ‘09 by roughly 5 months – we’ll see if it is right this time.
The bump in the discount rate is not officially counted as a rate increase, but it certainly shows the Fed’s intent. The bond model flipped negative last week and based upon the Fed actions of last week, may stay negative for more than just a couple of weeks. The spreads between the short and long-term interest rates remain very wide, indicating that the financial industry should still benefit. However, if the Fed is serious about “pulling the punch bowl”, then expect that long-term rates should remain stable while short-term rates rise, creating a flatter (or at least more normal) yield curve. Since inflation (as reported in the CPI and PPI figures) remains around the median range of the historical data, we don’t expect the Fed increases to be rapid whenever they begin to raise rates.
When the markets are doing well, the more defensive sectors tend to lag, while a declining market tends to favor the defensive groups. The recent strength in stocks combined with weakness in the pharma and medical equipment have put both groups back in the lower half of our ranking system, just after each had clawed their way toward the top. Healthcare as a whole dropped significantly over the past two weeks in our ranking system, making it among the worst (save for utilities and telecom) sectors. One group that has been rising in our rankings is the economically sensitive building materials group. Led by a huge jump in Watsco (WSO) on very good earnings and a dividend increase, the group has been also supported by stocks like Sherwin Williams (SHW) and Louisiana Pacific (LPX). Bouncing back and forth between economic growth and stagnation, many of the groups are making trips regularly to both the top and bottom quartiles of the ranking system. So in order to “play” the groups, it makes some sense to pick out stocks that are of interest and begin accumulating them on weakness, which will inevitably come in the weeks ahead. Many of the high quality companies are increasing their dividends as well, a sign – at least for them – that they are comfortable and confident in their businesses.
The two-week rise in stocks may be coming to an end, however as long as the decline is rather modest and does not come on higher volume, we could see still higher prices as the correction may be nothing more than another minor break in the persistently higher prices. Bond prices could see some weakness (as rates rise) reflecting the reality that the Fed is likely to be tightening monetary policy sooner rather than later.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.