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Home« Further Indication of a Stealth Tightening by the Federal Reserve
September 26, 2009: Month-to-Date Review of the Markets
Posted by Larry Doyle on September 26, 2009 9:49 AM |
Did the market put in a top this week? Is the Federal Reserve sending signs of taking its foot off the accelerator? Is the economy displaying an inability to gain traction? Will the G-20 communique make any real impact on our global financial system? Let’s review the market performance for the week and provide our month-to-date statistics while addressing the above questions. In the process, we can collectively ‘navigate the economic landscape,’ the mission of Sense on Cents. Let’s start our brisk Saturday morning hike with a quick review of the economic data which I deem most important and impactful on the markets:
Economic Data
>Leading economic indicators rose .6 with July’s reading revised upward from .6 to .9 . . . we put this in the net plus category . . .
>Durable Goods Orders posted a -2.4% reading vs. a consensus expectation of a 1% gain. The bulk of the decline was in transportation which is further indication that the Cash for Clunkers program pulled demand forward only to be followed by a big dropoff . . . a real negative
>New Home Sales also disappointed. The WSJ highlights,
Momentum in the housing market has slowed, indicated by yesterday’s dip in existing home sales and by today’s weaker-than-expected report on new home sales. New home sales edged 0.7 percent higher in August to a 429,000 annual rate that compares unfavorably with expectations for 445,000. August’s level would have been below July’s level were it not for a downward revision with July now reading 426,000 vs. an initial 433,000.
How did the markets handle the Fed, the data, and technical flows? Let’s continue navigating. The figures I provide are the weekly close and the month-to-date returns on a percentage basis.
Equities
DJIA: 9665, +1.8%
Nasdaq: 2091, +4.1%
S&P 500: 1044, +2.3%
MSCI Emerging Mkt Index: 908, +6.6%
DJ Global ex U.S.: 193.0, +3.9%
Commentary: equities on average declined by 2% on the week. This decline largely retraces the prior week’s advancement. In the process, have we put in a top in the market, at least for the short term? I believe we have and believe that top occurred on Wednesday after the Federal Reserve released its policy statement. I highlighted the price action of Wednesday in my commentary, “Equity Market Key Reversal on 9/23/09.”
What did the market see in reading through the Fed’s statement? Hints that the Fed knows it needs to lessen the flow of liquidity into the markets. Also, recall that the market price action for September had been a virtual straight line higher. I highlighted that fact a week ago. If, in fact, we just put in a short term top in the market, I would project that target support levels for the DJIA would initially be 9000-9100 (a 24% retracement of the March to September move of 6500 to 9900) and then 8600 (a 38% retracement). We shall see, but those levels represent key Fibonacci Retracement levels.
Bonds/Interest Rates
2yr Treasury: .99%, an increase of 1 basis point or .01%
10yr Treasury: 3.32%, a decrease of 9 basis points
This flattening of the yield curve is typically an indication that the market believes the Fed is preparing some sort of tightening. While the Fed is nowhere close to actually raising its Fed Funds Rate, we know its quantitative easing program and certain other liquidity measures have wound down and will continue to wind down over the next 1-6 months.
COY (High Yield ETF): 6.42, +6.1%
FMY (Mortgage ETF): 17.62, +1.3%
ITE (Government ETF): 57.86, +.1%
NXR (Municipal ETF): 14.27, +1.3%
Commentary: the market continues to easily absorb any and all government bond supply. I assess that development as a growing concern of deflationary pressures building in the market. Additionally, an overwhelming percentage of investor funds are going into bonds. I would be very careful about adding exposure to lower credit rated parts of the market given the outperformance of those funds to date (for example, high yield bond funds are up approximately 50% on the year). If, in fact, the economy is battling deflationary pressures (and it is) and the Fed is unable to keep ‘the pedal to the metal,’ then equities and other risk assets should retrace while Treasury bonds will appreciate.
U.S. Dollar
$/Yen: 89.85 vs. 93.11 at August month end
Euro/Dollar: 1.4670 vs. 1.4338 at August month end
U.S. Dollar Index: 76.81 vs. 78.14
Commentary: the overall U.S. Dollar Index increased by approximately .45% on the week. I do think there is a high negative correlation between the dollar index and our equity markets (dollar improves, equities weaken) as a large number of hedge funds and market speculators have sold dollars to buy global equities, a form of a ‘positive carry‘ trade. I would encourage people to track the U.S. Dollar Index closely as a good sign as to the near term direction of the equity markets.
I should highlight that the dollar did continue to weaken vs. the Japanese yen. MarketWatch reports:
The dollar remained down more than 1% versus the Japanese yen after Japan’s Finance Minister Hirohisa Fujii said he opposes intervening in the currency markets to curb the rise in the yen, according to media reports.
I feel compelled to repeat my statement of the last few weeks:
This ‘positive carry’ trade is nothing more than implementing leverage. Do not confuse leverage with brains when a market is rising because as I said the other day, leverage is death when that bull becomes a bear. As I think of market developments, I am convinced that this ultimate unwind of leverage trades currently being implemented is Jeff Gundlach’s reasoning for being bullish on the dollar. How will this work? Investors will look to exit their risk based investments (emerging market stocks and the like) and buy back the dollars which they have borrowed. In the process, the dollar may rally significantly. The timing of this unwind is the critical question.
Commodities
Oil: $66.09/barrel vs. $69.93 at August month end
Gold: $992.4/oz. vs. $952.4 at August month end
DJ-UBS Commodity Index: 123.37 vs. 125.73 at August month end
Commentary: I view this segment of the market to be the STRONGEST indicator of the global economic pulse. Additionally, the price action in commodities is likely a strong indication of the ‘positive carry’ trade put on by hedge funds and other traders.
The overall commodity index is DOWN 2% on the month. What are equity markets, especially emerging markets, doing up in the face of this price action? Great question.
Additionally, the Baltic Dry Index moved lower this week by approximately 4%. I view that movement as reason for concern. Can global equities in general and commodities specifically increase in value if the major indicator of global trade, that being the BDI (Baltic Dry Index), is in a downtrend? I think not.
Summary/Conclusion
With September almost in the rear view mirror and a number of market participants having salvaged very respectable returns on a year-to-date basis, I believe many fund managers and other market participants will look to lock in profits and returns and mitigate risk positions. What does that mean? I think cash will exit some of the riskier parts of the market and look for a safe harbor.
While the global government wizards meeting in Pittsburgh at the G-20 may have ‘smiled for the cameras,’ the released communique has ZERO enforcement capabilities and thus, I continue to maintain:
The overriding fact remains that the ‘Uncle Sam economy’ is continuing to adapt to the very changed nature of our underlying market and economic dynamics. That dynamic in which the securitization of assets remains a distant memory will force credit to remain tight. Consumers need to adapt accordingly.
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Thoughts, comments, questions always appreciated.
Have a great day and weekend.
LD
