Saturday, February 4, 2012

Macro Analysis 2/3/2012

This will be an abbreviated commentary and I will be back next week with a full commentary
Here are our inter market relationships:
       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 – Stocks had another strong week with the S&P 500 posting a 2.17% gain on the week and the Russell 2000, the bell weather small cap index, closed out the week with a whopping 4.04% gain.  Below is a daily chart of the cumulative NYSE New Highs-New lows Index with the NYSE Composite Index behind it.  The bottom panel is the Ratio of the New High-New Lows Index to the total number of issues traded on the New York Stock Exchange.  The chart speaks for itself.  Not only is the cumulative line approaching an annual high but the ratio is showing considerable strength as new highs as a percentage of total issues traded grow stronger and stronger.
Many in the market consider this index a lagging indicator of the general market with little or no predictive value.  But as someone who lives and breathes these markets I can tell you that this manifestation of strength is a very healthy sign that higher highs lie ahead for U.S. stocks.
Treasuries – had a crazy week as seen below with rates spiking down on Monday but closing the end of the week considerably higher.  Below is a daily chart of the Ten Year Treasury Note Yield. We had a break out of the triangle in mid January (“Head Fake”) but rates quickly dropped again.  On Monday we had a significant drop in rates as delineated by the purple arrow but then yields were essentially flat all week until Friday when they spiked on the good Employment report.
The Treasury and commodity markets are the most important markets to watch right now.  Both these markets will validate the direction of stocks in the mid to long term.  Those of you who read these commentaries know I’m bullish on stocks for reasons already mentioned and I have been looking for yields to back up at least 35 to 40 basis points from Friday’s close.  I believe Friday’s big move in interest rates was a key reversal and we are going to see higher rates in the coming weeks and months.  Higher rates mean a healthier economy as people and companies can weather the extra interest expense because they are doing better financially.
Please understand, if my thesis is right, rates will eventually stabilize in the 2.35 – 2.50% area and will stay in that general area as long as the FED continues to buy up debt in the “belly” of the curve (7 to 10 yr. paper).
Commodities –   I have not been impressed by the price action in the commodity arena as it has not kept pace with the stock market rally.  The Copper chart below is representative of the price action on many commodity charts.  We had a nice surge on Friday on the better than expected employment report but as you can see in the blue circle below, the industrial metal is presently trapped between two Fibonacci retracement lines and I need to see a definite breakout above 3.95 for confirmation that stocks are heading higher in coming months.  Indeed, we better start seeing a resumption of the uptrend that commenced in December.  If the stock market rally is real commodity prices should be following soon!
And what’s with Gold?  We had a significant sell off on Friday which, in the context of the market fundamentals that day, is totally uncharacteristic for the metal yellow.  As per our inter market relationships above, Gold rallies along with stocks and commodities on good economic news from the perception that a stronger economy stokes inflationary pressures.  The Dollar, which has an inverse price relationship to Gold started out Friday’s session strong but the gains dissolved as the day wore on.  Gold, however, started out weak and the price continued to drop throughout Friday’s session.
I don’t like this price action and while it’s true Gold had been experiencing a strong rally throughout January it is uncharacteristic that on the heels of the good economic news we received on Friday and stocks and commodities subsequent strong price action that we would see a $30.00+ drop in the metal.  I’m developing a thesis on why I think this is happening but will wait to see if there is more follow through to the downside next week before sharing it with you.

One of the reasons for an abbreviated commentary this week is that I don’t have much to say.  As I’ve stated a number of times, the “fix is in” in the Euro Zone with much more liquidity to come.  Central banks are being as accommodative as they can be (maybe too much) and the markets love this kind of environment.  We’re experiencing a feeble earnings season and stocks are still rallying and are within range of post crash all time highs on multiple indexes.

What might throw a wrench into the works?  Maybe a Greek default, but other than that, I see nothing on the horizon that would derail this rally.  And even a Greek default might not be as cataclysmic as some are predicting.  The concern here would be the total value of the derivative market connected with guaranteeing Greek debt.  But no one knows what the possible exposure is.  I’ve read estimates from near zero to trillions.  That means no one knows … J  In any case, Mario Draghi has accomplished what he needed to do to alleviate the crisis.  He’s pumped Europe’s banks with Euros thereby insulating them from any financial fall out from such a traumatic event.  I’d be looking at a Greek default as a buying opportunity as there would certainly be a sharp, significant sell off in equities which would quickly be reversed.

If my bullish thesis on stocks is correct we will see bond yields starting to back up and higher commodity prices.  As I said above, yields will not back up significantly but commodities should start seeing strong price action.  A failure of commodities to advance would make me have to reconsider my bullish thesis on the economy and equities.

Have a great week!