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Russell 2000
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World
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The potential for a Greek default unnerved investors in Asia and Europe
sending U.S. markets tumbling to begin the week. They recovered in
late Monday trading, however, on rumors that China was preparing to
make a substantial investment in Italian bonds. Stocks posted modest
gains with most of that coming in the final half-hour. Stocks continued
their winning ways Tuesday with the Nasdaq again showing relative
strength on a flurry of share buyback conjecture. Supportive words
from Sarkozy and Merkel after a conference call with Greek PM Papandreou
gave stocks all the impetus they needed to build a third day of gains.
Chip stocks were notably strong powering the Nasdaq 100 higher once
again. Higher jobless claims failed to derail a week-long stock rally
as that domestic negative was more than offset by announcement of
coordinated global central bank support for European bank stocks.
With the near-term threat of financial contagion seeming to be contained,
stocks were able to build on their weekly gains by more than 1%. Friday
saw a strong showing by retail stocks, who joined Nasdaq 100 components
to give the week a full five days of positive closes.
A burst of optimism regarding Eurodebt supported a five-day rally
leaving the S&P 500 (SPY)
up 4.83%. The Nasdaq 100 (QQQ) continues to be the leader, this week
posting a 6.41% gain. The Russell 2000 small-cap index (IWM)
was solid
also lifting 5.96%.
Our World portfolio rose 2.01%
on the week propelled by U.S. indexes. With the Classic Model
on a Sell signal, the World
approach calls for staying in cash if you follow the "Long
Only" methodology, or taking a short Nasdaq 100 (QQQ) position
if the "Long and Short" strategy is your guide. Only
Buy-and-Rebalance followers should be invested in the World
portfolio at this time. Go to the Classic Model "Description"
page for a more detailed explanation of the strategy choices.
Both the Classic model and Turbo Model
remain Sell.
Mr. Bull, leaving so soon?
Cyclical bull rallies usually last 2-3 years when the market
resides in a broader "secular" bear period. The secular
bear period is defined by an erosion of investor enthusiasm for
the asset class, stocks in this case. We see that erosion through
dwindling P/E ratios, recent evidence of which was provided by this
article from Reuters:
"Analysis: Big-name stocks cheaper than during 2008-09 crisis".
The 2-3 year period of relative happiness that fuel the cyclical
bull come as investors return to buying beaten-down stocks on the
perception that the economy and/or whatever ails us has been put
in the rearview mirror. As the cyclical bull ages, the initial high
wears off and worries begin to return. The first worries are typically
those of the ever-feared "double-dip" recession. This
often brings about a market correction where investors take profits,
stocks fall 10% or so, and there is a pause to reflect. (During
this cyclical bull rally we saw these double-dip fears show up in
the summer of 2010.) Once investors skip past those worries, stocks
resume their upward trajectory until the next hurdle comes along.
As shown in the chart below, the second year of the cyclical bull
was a rewarding experience for stocks. However, the lingering anchor
of financial issues in the chart speaks of the problems overhanging
the market's progress even as the broader indexes showed nominal
gains. (We know now that a large part of those gains dissolved in
quick order.)
Chart 1: Second year of cyclical bull market rewards all
but one
In a weak secular (aka "long-term") bear period, however,
there isn't enough firepower in the bulls arsenal to successfully
work through all the hurdles the market faces, and/or the hurdles
may just be too large to overcome. Such has been the case over the
summer of 2011.
We have referenced the Eurodebt problems many times in our Weekly
Updates. Similar to the U.S. financial crisis in 2008, the Eurodebt
troubles escalate in fits and starts with each finger in the dike
merely creating a bigger area of pressure to be dealt with. The
rumor this week of China buying Italian bonds (and a sharp Wall
Street rally as a result) was again similar to the hope and wishes
that occurred in 2008 as investors wished and hoped that the Fed
and Treasury would have some answers. The problem in Europe is that
there is no single entity that has the authority to deal with Greece,
et al. It's being created and made up as they go. Presumably, Europe
will emerge either as one stronger unified entity from these trials,
or will split back into many separate pieces. For now, Germany and
France are compelled to try and keep things together, though the
markets have essentially told them that Greek finances are done
for. This drama has met up with U.S. economic stagnation and a slowing
China to send the cyclical bull back into hiding.
Chart 2: Cyclical bull loses its way as investors shift
to defensive sectors
The economically-sensitive sectors of basic materials and industrials,
leaders when the economy is rip-roaring along, have begun following
lowly financials down the bearish path. We would now expect a 12-18
month period of relative weakness for stocks with, at best, sideways
range-bound trading. The current situation is outlined below in
the point-and-figure chart. Point-and-figure charts are good at
identifying trends and support/resistance spots because they only
take price into consideration, not time. Thus, they are mapping
movements in price only. For example, if the price of the index
remains at a flat level for one week, the point-and-figure chart
will show nothing.
Chart 3: Stocks digest August swoon before ... what?
Chart 3 shows how the last bear market in 2008 developed and where
we are in the current process. The point-and-figure style of chart
shows well the process of "digesting" sharp moves, up
or down, as markets trade sideways to "get used to" the
new price level. We are in the midst of this digestion phase right
now, with swings back and forth within a very clear band. At some
point, one side of this "discussion" will grow tired of
participation and give way to the other side, either propelling
us back upward as we outlined in the Weekly of two weeks past, or
dropping us lower into the next channel down. Our expectation is
that the resolution will be lower as is typical of this phase in
the market cycle. But who knows? Occasionally during these periods
something comes out of left field to shock investors, such as a
big merger/acquisition announcement which causes investors to rethink
their recent gloom-and-doom. Until that happens, we remain on alert,
Europe remains on the edge, and right now, both Classic and Turbo
are choosing to share our caution.
Question: How is it possible the U.S. dollar is shooting
up given our domestic fiscal troubles?
We have written in the past how currencies are driven as much by relative
interest rates as anything. Like all assets, currencies also reflect
investor sentiment, confidence in the issuer, etc. With U.S. interest
rates remaining at rock-bottom levels, it seems odd that the U.S.
dollar has managed two significant gaps higher (see Chart 4 below).
Chart 4: U.S. dollar gaps higher on Euro woes
U.S. Treasury rates have notched new lows recently, which we would
expect to drive the U.S. dollar down further as investors are receiving
virtually zero compensation for investing in U.S. assets compared
to, say, Brazil or Australian currencies which yield a good deal more.
Such is the odd behavior of a "safety" asset, because currencies
are a relative game. It's all in how one looks compared to another.
While many in the U.S. may not view our domestic financial situation
to be all that rosy, investors still look at the U.S. as a safe-haven.
For a few months, investors tried to use the Swiss Franc as a safety
asset only to be rebuffed last week by the Swiss central bank, who
took action to try and punish investors for thinking such thoughts.
The U.S. has no similar qualms. The U.S. dollar has already been falling
significantly over the past year reflecting our cheap, cheap money.
If we retrace some of that move down and can offer safe harbor for
nervous money, it will be our pleasure. Being a safe haven has rewards,
after all, as continued hefty purchases of U.S. debt by foreign governments
attests. With the Euro on ever-shakier ground, investors are fleeing
to other currencies. The U.S. dollar looks a whole heckuva lot better
by comparison.
Warm wishes and until next week.
TheTimingCube
Staff
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