Sense on Cents

A cursory review of market returns for June indicates no dramatic shifts, so let’s go to the sports pages, right? No, don’t do that! In the Brave New World of the Uncle Sam economy, every day, week, and month provides historic developments both above and below the surface.  How does one possibly navigate the hills and valleys of the markets and economic landscape? Welcome to Sense on Cents!

I had forecasted in the Sense on Cents May 2009 Market Review:

Add it all up and I think the following will occur:
– equity markets will now move sideways in range bound fashion;
– the bond market will move lower in price, higher in rates;
– the dollar will gradually decline;
– our economy will be filled with more stops than starts.

Let’s review the stat sheet, assess our May calls, and forecast what we see on the horizon. As we move along, let’s continually remember the largest player in our markets – both literally and figuratively – is none other than Uncle Sam himself.

Pimco’s Bill Gross said a few month’s back, “you should keep the big uncle in clear sight and without back turned.” The Wall Street Journal reported just yesterday in Inflation Fears Seem to Be, Well, Inflated:

Given the Fed’s heavy and unpredictable hand in the market lately…

Yes, Uncle Sam is casting an ever larger shadow across our economy and markets. Let’s navigate . . .

Market Returns:

Equities: the major market averages (the DJIA and S&P 500 especially) ended the month largely unchanged. In fact, the S&P 500 ended the month exactly unchanged. That said, the markets had an overall range of approximately 6%-7%. Why so volatile? Primarily a continuation of technical flows of funds, while the economic fundamentals remain decidedly mixed.

The tech heavy Nasdaq continued to outperform given some positive earnings developments (e.g Oracle) and lessened debt burdens. Given the Nasdaq’s dramatic outperformance, I would be reluctant to add exposure to this sector.

Sense on Cents’ self-assessment of May call: very solid

Bonds: while the 10yr Treasury ended largely unchanged on the month, it experienced a major selloff and actually broke above the 4% level for a short stretch mid-month. The upward pressure in rates, about which Sense on Cents wrote extensively, raised major concerns about potential inflation, economic recovery, and the equity markets.

Rates came back down over the last week. Cooler heads prevailed, right? Or did that “heavy and unpredictable hand of the Fed” go to work? Sense on Cents feels strongly that the Fed managed to move rates lower via quantitative easing and working with Treasury which had redefined indirect buying in Treasury auctions (“Turbo-Tim Takes ‘Indirect’ to a Whole New Level”).

While the government bond sector did post slightly negative returns for the month, the credit sensitive sectors of the bond market (corporates, high yield, municipals, and mortgages) did post low single digit returns. What is driving cash into these sectors? The fact that the Fed and banking system at large are holding short term rates (including savings rates and CDs) at near zero or marginally above is literally compelling both consumers and investors to seek some degree of return elsewhere. That money is flowing into these bond funds as investors remain extremely concerned about the economy and equity markets.

Are investors being lured into a potential trap by investing in bonds? I believe they are. I do not see the pressure of global government deficits along with refinancing pressures throughout the economy abating anytime soon.

Sense on Cents’ self-assessment of May call: fair (more…)