Stocks posted a
marginally positive week although price action was lackluster. But at least the volatility has
subsided. And while I could never say
we’ll never see volatility again like we did in the second half of ‘11 I do believe
that the constant nerve wracking market action we’ve experienced is over. Euro Zone fears still seem to dominate small
investors psyches as we still do not see significant money flows out of the
safe haven trade (Treasuries, bonds) and into “risk on” assets but the market
continues to trudge along, climbing that “wall of worry”.
I haven’t posted our
inter market relationships in a few weeks so here they are:
Inflation Deflation
If Stocks rally correct
Then Treasuries will correct will rally
Then Gold will rally will correct
Then Commodities will rally will correct
Then US Dollar will correct will rally
Stocks – as measured by the broad Wilshire 5000 Index were up 0.41%
this week. Here’s a weekly candlestick
chart of the Russell 2000 Small Cap Index which was up 1.81% on the week:
What I want you to take
away from this chart is the fact that Small Cap (capitalization) stocks are
starting to outperform the bigger multi-nationals (bottom panel) which is
predictive of a stronger market going forward.
Also note the strong trajectory on the MACD indicator (top panel) and
the price action itself is very deliberate.
This is the kind of price action reminiscent of the last halves of 2009
and 2010. I’ll be discussing why I
believe the market is acting like this in my ANALYSIS.
I posted a number of
breadth indicators last week so I’ll just put one more up to show you how
strong this market really is:
This is a four year
chart representing the percentage of stocks on the NYSE that are trading above
their 200 day moving averages. As you
can see we closed on Friday at 65.10% and are fast approaching the 70% level
(purple dashed line). This is very healthy
action and represents the internal strength of this market. All we are missing is volume which hasn’t
been what it should be for the reason I addressed at the beginning of this
commentary.
There was some churning
this week in that TRIN (Short Term Trading ARMS Index) has been over 1.00 which
is signaling that many stocks were weaker during the week. Most pundits have been saying the market is
overextended here and many are looking for a correction. But the fact that TRIN has been in bearish
territory and the market has finished positive for the week is telling me that
we’re liable to see this overbought condition work itself off in sideways price
action rather than a correction. I
posted a chart on my blog this week
(http://equitymaven.blogspot.com/2012/01/what-street-is-concerned-about.html)
that further supports this thesis.
In my mind, stocks are
set to move significantly higher in the next few months. I’ll extrapolate on this thesis in my
ANALYSIS.
Treasuries – got a shot in the arm after the FED announced on
Wednesday that they intended to keep short term interest rates low until at
least 2014. Rates had been creeping
higher up to that point which was signaling an incrementally strengthening
economy. This artificial “put” on
interest rates is starting to skew our inter market relationships which have
served us well for the past few years.
But as you will see on the first chart below of the iShares Barclay 7 to
10 Yr. Treasury Bond Fund (IEF), pressure is building on the long end of the
yield curve. There is significant
resistance at the 105.75 – 106.00 level and the MACD indicator in the panel
above is showing significant momentum deterioration.
No one, not even the FED, can control long
term interest rates save for short time frames.
The bond market is just too big for any one entity to manipulate
it. Nevertheless, while I think long
rates will back up there will be no significant move to the upside. There are just too many global deflationary
forces impacting these markets and we must remember that the FED is still
active in buying up securities in the 7 to 10 year range. Remember Operation Twist?
Assuming continuing
improvement in economic fundamentals how far could rates back up? I could see a back up on the 10 Year Treasury
Note at around the 2.35 to 2.40% level and perhaps as high as 2.5%. The Ten Year closed on Friday at 1.893%. The second chart below shows how I determined
these projections.
In any event, we’re in
a low interest rate environment which will continue to be supportive of
equities (unless they get too low; like less than 1.692%).
Commodities – were mixed
this week, with livestock (except cattle) and grains basically treading water
while industrial metals and precious metals reacted positively to the FED
announcement. The industrial metals have
been in a steady uptrend since mid December as a result of the ECB’s LTRO which
I’ve addressed in previous commentaries.
The FED announcement just gave an additional “goose” and the trend is
firmly entrenched.
Gold and Silver took
off on the FED announcement and many are heralding a resumption of the bull
market in precious metals. To this I
will not argue as I believe this time the FED has it wrong and this move will
fan the inflation fires going out to the mid decade (if not before). But the real story with the precious metals
was the boost that the Gold mining stocks received this week after the FED
announcement. Below is a chart of GDXJ
(Market Vectors Junior Gold Miners ETF).
The mining stocks have been lagging the metals for most of the multi
year rally in the precious metals, which has confounded many market
pundits. Various excuses have been given
why they are not reacting the way they did in the last bull market in Gold
(1979-1980). Probably the most plausible
reason has been the fact that with the advent of ETFs it has become much easier
for the small investor to take a paper position in Gold or Silver. In the past, if you didn’t physically buy the
metal then you had to take a position in the futures market which many small
investors are loathe to do (and for good reason). So, investors would use the mining stocks as
a proxy for the metal.
In any case, last
week’s price action is highlighted with the green circle.
Notice the long clear candle inside the green circle. That was Wednesday’s price action after the
FED Announcement. The ETF jumped
$2.00/share! This index captures the
price action in the more speculative, smaller cap mining stocks which is an
excellent indicator of the future direction of all the miners. Is this the beginning of the big rally in
mining stocks all the gold bugs have been waiting for? I’ll wait until the ETF penetrates the 50%
Fibonacci retracement area I highlighted with the black arrow. Ideally, I would like to see a filling in of
the gap that formed in mid September (black circle). Something to keep our eye on …
US Dollar – I haven’t addressed the dollar much in my 2012
commentaries but those of you who regularly read me know it was a regular topic
in 2011. And I wouldn’t want anyone to
think that the Dollar is no longer important.
As I’ve said many times, if you want to know where risk assets are
going, watch the Dollar!
The FED announcement wounded our currency which had been weakening
considerably since the successful European debt auctions earlier in the
month. As things are perceived to be
getting better in Europe the Euro is strengthening and since the Euro is
roughly 57% of the Dollar index as the Euro moves higher the Dollar weakens
proportionally.
A weaker Dollar has been good for stocks in the deflationary environment
we find ourselves in as its weakness stirs inflationary pressures. However, this is a double edged sword because
as prices rise it squelches consumer demand.
No greater example of this can be seen than in the price of oil and
gasoline.
In past commentaries I’ve posted charts of West Texas Intermediate Crude
showing significant resistance at the $104.00/barrel level. Oil’s price action has been muted recently
and even the Oil Service Holders (OIH) have had a lackluster performance in
recent months. This state of affairs
cannot continue. There is an inverse
relationship between the price of the Dollar and oil. Either Oil has to start rallying or the
Dollar has to stop its decline and strengthen.
There are signs of an inverted head and shoulders formation on the West
Texas Crude chart which is predictive of higher prices and on the chart below
we can see the spot gasoline price has broken out of an eight month downtrend
(blue line) and on Friday took out another intermediate term resistance line
(red line) going back to September.
All this is supportive of more dollar weakness which coincides with the
fundamental picture after the FED’s action this week.
A weakening Dollar will initially be supportive of stocks but if we start
seeing significantly higher gas prices, consumption will become constrained
with a corresponding deleterious effect on the economy.
ANALYSIS
I’ve made the case in the past
two commentaries that the “fix was in” after the European Central Bank pumped
close to 500 billion Euros (about 640 billion dollars) of liquidity into
European banks. This action has
effectively neutered the threat of a European sovereign debt implosion. We’ve seen yields on Italian and Spanish debt
drop since the December 21st LTRO and although Portugal is starting
to have problems in controlling their financing costs the contagion looks like
it’s contained. At this point, based on
the action in the European bond market, if I had to bet which countries would
leave the EU in 2012, I’d say it’s a safe bet that Greece is a definite and
Portugal is a prime candidate.
We’re not out of the woods yet but I think Mario Draghi is going to
administer the “coup de grace” to the crisis next month when the ECB extends
another LTRO (Long Term Refinancing Operation) to the European banking system
with even more liberal credit terms (allowing bank loans as collateral). Rumors are out there that the ECB may offer
up to a trillion Euros this time around which will expand the ECB balance sheet
even more than the FED’s. If this next
LTRO unfolds according to the rumors the Euro Zone debt saga will dissolve.
Now the FED has stepped in with
talk (jawboning) of keeping short term interest rates low until the end of
2014. Liquidity abounds! And the market loves liquidity! I would submit to my readers that at this
point, regardless of economic fundamentals, this extraordinary liquidity has
put a floor under equity prices and can be the catalyst for significantly
higher prices going forward.
With the attention now off of
European debt woes, much has been made that earnings will be the main driver
for US stock prices going forward. And,
as it stands right now, only 57.9% of all US companies that have reported this
quarter have beaten analyst earnings estimates.
During the August to November market turbulence, the correlation among
stocks was high at 0.9, meaning most stocks were moving in unison, either up or
down. Now, that correlation is 0.15. So,
we’re now in a market where you’ve got to pick the right stocks but the trend
is still pointing to significantly higher prices.
The key, in my mind, to
understanding this market is the incredibly low yields on risk free money. The yield on the five year Treasury note
closed on Friday at a record low of .75%!
Who, in their right mind is going to tie up their money for five years
for such a paltry return?
So where do you put your
money? If you know you’ve have central
bank support in terms of liquidity the only viable option to making money in
these markets is to buy high dividend yielding, preferably multi-national
companies that can withstand any sudden downdrafts that may unexpectedly
surface in the next few months. Stocks
like IP, MRK, PFE, KFT, T, VZ and GE.
These will continue to appreciate and pay you handsomely to wait out any
downside or sideways price action, regardless of earnings report surprises.
I want to leave you with some
thoughts on what I see as the bigger picture.
Those of you who read me regularly can probably gauge that I write these
commentaries with a three to six month window in mind. And regardless of accuracy (or lack thereof)
in my prognostications I know that no one can accurately predict what the
financial markets are going to do. I’m
not telling anyone something they don’t already know but I only make this
cautionary introduction to state the following hypothesis.
I’m not an “Armageddon scenario” proponent and
I normally eschew such predictions.
However, more and more, as I follow these markets on a daily basis and I
see the interventions made by governments and central banks to stave off
financial disaster, I come away with the feeling that we are more and more
“pushing on a string”.
Central banks, in their Keynesian
understanding, are playing a very dangerous game. And while I believe that the FED’s decision
in late 2008 to pump the economy with money was the right one, subsequent
interventions are more and more getting “less bang for the buck”.
For the Keynesian “solution” to
work time is needed. Indeed, sovereign
entities and their banks are gambling that eventually real growth will kick in
which will eventually eat away the trillions of dollars in debt that the globe
is buried under. But this will take
years to accomplish as leveraged debt is still being unwound. And even if the Keynesian prescription is
eventually successful, I don’t believe everyone can survive unscathed.
So it’s a precarious balancing
act that’s being implemented with a number of questionable assumptions that are
held as sacrosanct. We can only hope
that we don’t get thrown a curve ball that knocks down this house of
cards.
We need time. Will there be enough?
Well, it’s the world we live in
and I wouldn’t want it any other way. It
gives me something to write about! J
Have a great week!
Positions: PRPFX (long); SMH
(long); ARR(long);CEF (long); CUZ (long);IP (long);MFA (long), NLY (long); XLU
(long), EUO (long), COG (long)
NOTHING IN THIS COMMENTARY SHOULD BE CONSTRUED AS AN OFFER OR ADVICE TO BUY OR SELL ANY SECURITIES, OPTIONS, FUTURES OR COMMODITIES. THE OPINIONS ARTICULATED ARE ONLY THIS AUTHOR'S WHO IS NOT A LICENSED INVESTMENT COUNSELOR OR BROKER.
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