Sun 21 Mar 2010
Posted by Prieur du Plessis under Investment, Markets, Money
The major stock market indices added to their gains this week - obtaining comfort from the Fed’s policy statement that the “juice” was not about to be removed anytime soon - and hit 18-month highs before closing down on Friday as “quadruple witching day” in the US weighed on sentiment. A day earlier on Thursday, the S&P 500 tracking ETF (SPY) broke a 14-day winning streak - its longest since the launch of the ETF in 1993.
The Federal Open Market Committee (FOMC) on Tuesday once again announced that the fed funds rate target was likely to remain “exceptionally low” for “an extended period”. The communiqué was slightly more upbeat on the outlook for the economy, saying the labor market was “stabilizing” (last statement: “the deterioration in the labor market is abating”), although a number of constraints on growth remained.
The FOMC’s statement “met market expectations on the three key aspects of leaving interest rates unchanged, maintaining dovish language about future policy moves and allowing the special programs to lapse,” Mohamed El-Erian, chief executive and co-chief investment officer of Pimco told Reuters (via MoneyNews). He added that the end of the Fed’s program of purchasing $1.25 trillion of mortgage-backed securities at the end of March signaled a form of credit tightening. Traders are also expecting an increase in the Fed’s discount rate from 50 basis points above the fed funds rate to the pre-crisis margin of 100 basis points.
Meanwhile, US Senate Banking Committee chairman Christopher Dodd introduced a revised version of a financial regulatory reform bill on Monday. “The Act’s reduced risk retention requirements and its recognition of its potentially negative impact on access to credit by consumers and businesses are encouraging, but the amount of discretion left with the regulators would be troubling to securitizers and originators. However, the delay in the effectiveness of final implementing regulations until, at the earliest, 2012, would give the industry an opportunity to adjust to the new requirements or to petition Congress for relief,” reported lawyers Edward De Sear and Charles Sweet (Bingham).
Source: Tom Toles, GoComics.com, March 18, 2010.
The past week’s performance of the major asset classes is summarized in the chart below - a somewhat mixed picture with equities, high-grade corporate bonds, gold, government bonds and the US dollar all higher as pundits waxed and waned between risky assets and safe havens. However, oil and commodities were pushed lower on the back of the stronger greenback. It should be interesting to see how the bond vigilantes handle this week’s auction of $118 billion worth of Treasuries, in the joint-largest auction on record. (For some perspective regarding the short-term outlook for the various asset classes, click the following links for Adam Hewison’s (INO.com) latest technical analyses: S&P 500, US dollar, gold bullion and crude oil.)
Source: StockCharts.com
A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below.
The cyclical bull market that commenced on March 9, 2009 marched higher during the past week, albeit with some hesitancy and a weak finish by the close. The MSCI World Index and the MSCI Emerging Markets Index gained 0.8% and 0.9% respectively.
As one would expect during a bull market, small caps have been a leading performer since the low of March 9 last year, with the Russell 2000 Index gaining 96.3% compared to a rise of 71.4% in the S&P 500 Index. Considering the last few days, however, small caps seem to have been tiring. As a result, the Russell 2000 Index has been the only major US stock market index to register a loss for the past week. As mentioned in a post yesterday, I will be keeping a close watch on this possible canary in the coalmine in order to gauge the most likely short-term direction for small caps and stocks in general.
Click here or on the table below for a larger image.
Top performers among the entire spectrum of stock markets this week were Ukraine (+8.1%), Qatar (+7.3%), Thailand (+6.7%), Uganda (+4.8%) and Greece (+3.7%). At the bottom end of the performance rankings, countries included Cyprus (-6.7%), Costa Rica (-3.5%), Malawi (-3.4%), Nepal (-2.8%) and Macedonia (-2.7%).
Of the 96 stock markets I keep on my radar screen, 64 (last week 74%) recorded gains, 33% (21%) showed losses and 3% (5%) remained unchanged. The performance map below tells the past week’s mostly bullish story.
Emerginvest world markets heat map
Source: Emerginvest (Click here to access a complete list of global stock market movements.)
Nine of the ten economic sectors of the S&P 500 closed higher for the week, with Telecoms (+2.4%) and Industrials (+2.2%) leading the pack and Energy (-1.1%), Materials (+0.2%) and Technology (+0.2%) forming the rear guard.
Source: US Global Investors - Weekly Investor Alert, March 19, 2010.
John Nyaradi (Wall Street Sector Selector) reports that as far as ETFs are concerned, the winners for the week included iShares MSCI Thailand (THD) (+6.2%), iShares Dow Jones US Health Providers (IHF) (+4.2%) and iShares MSCI South Africa (EZA) (+3.7%).
At the bottom end of the performance rankings, ETFs included First Trust ISE-Revere Natural Gas (FCG) (-5.7%), United States Natural Gas (UNG) (-5.5%) and Claymore/MAC Global Solar Energy (TAN) (-5.4%).
Criticizing Paul Krugman’s comments that the US should consider a 25% surcharge on Chinese goods, the quote du jour this week comes from Stephen Roach, chairman of Morgan Stanley Asia. He said in a Bloomberg interview: “We should take out the baseball bat on Krugman. … They don’t want to look in the mirror. America doesn’t have a China problem. It really has a savings problem. America has the biggest shortfall of national savings of any leading country in modern history. And when you don’t have savings you have to run current account deficits to import surplus savings from abroad and run massive trade deficits to attract the capital. Last year America ran trade deficits with over 90 - that’s right nine zero - countries. … Isn’t it the height of hypocrisy that America can articulate a particular position in its currency but the Chinese are not allowed to do that.” (Hat tip for transcript: Credit Writedowns.)
Elsewhere, the Financial Times reported that President Barack Obama appeared to be nearing victory in his epic struggle to push healthcare reform through a reluctant US Congress in a vote today (Sunday).
Next, a quick textual analysis of my week’s reading. This is a way of visualizing word frequencies at a glance. The usual suspects such as “bank”, “debt”, “government”, “market” and “rate” featured prominently, with “China” also again in the limelight as China’s Premier Wen Jiabao rebuffed calls from the US for the renminbi to appreciate.
The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town when not traveling) are given in the table below. With the exception of the Shanghai Composite Index that is flirting with its 50- and 200-day lines, the indices in the table are all trading above their key moving averages.
The table also provides the February lows for the various indices as these must hold in order for the cyclical bull market to remain intact.
Click here or on the table below for a larger image.
I am repeating the following paragraph from last week’s review as it is worth revisiting: “Using Fibonacci retracement lines, the S&P 500 is now testing the 62% retracement line drawn from the May 2008 peak to the March 2009 bottom (see purple lines). According to John Murphy (StockCharts.com), a break of this key upside target raises the possibility that the Index could retrace 62% of the entire bear market that started in the fourth quarter of 2007, in which case the potential upside target is 1,232 (see green lines).”
Source: StockCharts.com
Also commenting on the technical picture of the S&P 500, Kevin Lane (Fusion IQ) said: “We remain cautiously optimistic with the trend up, internals strong, the Russell 2000, the NASDAQ and now the S&P 500 at new recovery highs. Skeptics remain the loudest people in the room and while their concerns may be valid we have learned that the market rewards the minority and confounds the majority. The S&P 500 cleared its previous resistance peak near 1,150 and now looks to challenge the 1,200 level. Although there may be some back and filling along the way, we have long argued that there would be one last move up driven by investors who skeptically avoided the market.”
A week ago, Jeffrey Saut (Raymond James) said: “Nassim Taleb (trader extraordinaire) has 10 rules. Rule number 8 reads: ‘No matter how confident, always protect the downside.’ We agree and therefore always try to ‘look’ down before looking up in an attempt to manage the risk. As for the ‘here and now’, the broadest index of them all, the Wilshire 5000, has strung together 11 consecutive higher sessions, a feat not seen since the mid-1990s. Accordingly, it is pretty overbought on a short-term basis. That upside skein can be seen in the candlestick charts, which have not experienced a downside ‘red candlestick’ session since the upside reversal of February 25, 2010. [PduP: Last week saw three declines.]
“We are therefore turning cautious, but not bearish, on a trading basis. That strategy suggests a short-term correction is potentially due, but NOT an intermediate-term bearish decline. Indeed, since the end of the envisioned January/February ’selling stampede’, we have been constructive on stocks. However, we currently think pairing some trading positions, and/or raising stop-loss points, is warranted.
“Meanwhile, the Reuters/Jefferies CRB Index (commodities) broke below its rising trendline, the 10-Year Treasury Yield Index (TNX/3.71) broke above its 50-day moving average (read: higher rates), the Volatility Index (VIX/17.58) continued to trade below 18 (read: too much complacency), mutual fund cash positions are at historic lows of 3.6%, and the NYSE overbought/oversold indicator tagged a rare overbought reading above 90 last week. Ergo, color us cautious in the very short-term.”
“Where breadth goes, the market usually follows,” goes an old market saw. Analyzing market internals, the number of S&P 500 stocks trading above their respective 50-day moving averages has increased to 87% from 21% in early February (see chart below). “At these levels, there really hasn’t been much more room to run on the upside before a short-term pullback (or at least sideways trading) has been seen,” said Bespoke. For a primary uptrend to be in place, the bulk of the index constituents also need to trade above their 200-day averages. The number at the moment is 90% - somewhat down from its September peak of 95%, but nevertheless firmly in bullish terrain.
Source: StockCharts.com
In addition to being overbought, the S&P 500 is also now expensively valued on a long-term cyclically adjusted PE (CAPE) basis, according to Robert Shiller, economics professor at Yale and author of, among others, Animal Spirits, Subprime Solution and Irrational Exuberance.
In order not to work with notoriously unreliable forward-looking earnings estimates, I have always preferred using Shiller’s CAPE methodology, or normalised earnings, as they average ten years of earnings. This measure provides a good picture of the market’s value regardless of where we are in the business cycle. I have therefore been updating a CAPE chart for a number of years. On this basis, the multiple has increased to 20.5 since the March low of 13.3, representing an overvaluation of 25.0% when compared to a long-term average of 16.4.
For more discussion on the economy and financial markets, see my recent posts “Picture du Jour: Keep an eye on small caps“, “Government bonds - what’s up?“, “Is real estate rolling over?“, “Technical Talk: One last move up“, “Chinese stocks - finely balanced“, “Stock market valuation is stretched on long-term basis“, “Author Michael Lewis on Wall Street’s delusion” and “Barron’s Confidence Index - more work to do“. (And do make a point of listening to Donald Coxe’s webcast of March 19, which can be accessed from the sidebar of the Investment Postcards site.)
Twitter and Facebook I regularly post short comments (maximum 140 characters) on topical economic and market issues, web links and graphs on Twitter. For those readers not doing so already, you can follow my “tweets” by clicking here. You may also consider joining me as a friend on Facebook.
Economy The Recession Status Map below, courtesy of Dismal Scientist Economy.com, aggregates growth statistics from around the world and allows one to see at a glance which economies are in recession, at risk, recovering or expanding. Click here to link to the interactive version.
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