Nolte Notes for the week of April 30, 2012Paul J. Nolte - Monday, April 30th, 2012
Double ententres abound with an album by the Doobie Brothers entitled “What Once Were Vices are Now Habits”. Over 35 years later, you have to wonder what our leaders are smoking to repeat the mistakes of the past two years and expect different outcomes. The highlight of the week was the press conference by Fed Chair Bernanke where he answered questions about policy and economic views. The door remains open for more quantitative easing while maintaining near zero short-term rates through 2014. While we are experiencing an economic recovery, the debt overhang that is being added to daily, remains a drag. Spain’s debt was downgraded last week to BBB status, with the US on the watch list once the election cycle plays out. The “temporary” measures of the past have created a habit of easy money that eventually will cripple the world economies, just not this week.
An earnings induced rally, led by Apple’s incredible report and positive surprises from the likes of Amazon and E-Bay pushed the markets higher on the week after some early missteps. Ignoring the Spanish downgrade and some weaker economic data, the markets focused on the possibility that Bernanke “could” provide additional liquidity “if necessary”. The market advance did “broaden”, with more stocks advancing than declining, and while volume didn’t expand, it is running slightly higher than the past few weeks. A potential sign that this year may not be the same as the last few, where investors did well by selling in May is that investor sentiment is at or below the lowest levels all year. Sentiment is far from an exact science, but going into the summer last year, the bullish view was even higher than what has been the first quarter peak. Since that peak, the markets have rallied roughly 5% as investors have become more bearish. Generally sentiment runs counter to the markets, with high bullish readings usually occurring near peaks and high bearish near bottoms. As with many indicators we review, the markets are marching to their own tune this year led by conductor Bernanke.
The downgrade of Spain led investors to the relative safety of US treasury debt, pushing yields back below 2% on the 10-year bond and maintaining the relatively narrow trading range of the past 8 months between 2.25% and 1.75%. That small 50 basis point range is rather large in the context of today’s low yields, but more an indication that investors are not willing to make significant bets on when the Fed will change their rate policy. The bond market has been supported by both lower corporate yields as well as commodity prices. The healthy companies have been using the low interest rate environment to restructure their debt by reducing charged rates and extending maturities, effectively strengthening their capital structures. Until the economy exhibits persistent strength, expect that interest rates will stay low with only modest moves higher.
A check though the industry groups usually provide a good idea of the leadership and by extension maybe what the markets are expecting from the overall economy. Recently the more defensive groups have been performing better, expecting that the economy is slowing and as in the past two years, time to “sell in May and go away”. However, a closer look at some of the sub-sectors shows a split personality, with some defensive groups, but some very cyclical groups leading the way. For example, housing and related groups are among the top groups, perhaps an indication that investors believe the worst is over and housing is in the process of regaining their footing. Homebuilder Toll Brothers (TOL) is now at their best level since 2008. Retailer Home Depot (HD) is now at a 10-year high, after spending much of the last decade traveling between $20 and $40/per share. Industrial suppliers like Fastenal (FAST) and Grainger (GWW) are also among the top performers, but these stocks maybe in the early stages of a correction as FAST has already dropped 10%, while GWW has recovered most of the latest 10% decline. Cyclical issues like coal, aluminum and steel also are among the worst groups, so much like the uneven economic growth, so too are the industry group performance.
Investors will turn toward economic data this week, with Friday’s employment report being more important than usual given the wide range of estimates. Stocks look poised to break out of their corrective range, but would rather see prices jump on better volume for confirmation. Bond investors have been bounced around, as yields remain volatile. The best part of the yield curve remains in the 5-10 year range and in the BBB quality range.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.
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