Nolte Notes for the week of October 1, 2012Paul J. Nolte - Monday, October 1st, 2012
It is third and a long way to the end of the year! The professionals are trying to get back onto the field, as hedge funds and many active managers trail the broad SP500 going into the fourth quarter. The game has been compromised by the heavy hand of the Fed, pouring ever more liquidity into the markets in hopes to make the finish exciting. The field of play is a mess, with lousy economic data from the manufacturing sector and poor data from Europe. Investors have been on the sidelines watching in disbelief as the markets continue to push higher. The fourth quarter kicks off in frenetic fashion with the national manufacturing report, unemployment on Friday as well as global reports on economic activity from China and Europe. The forever election season also hits their final turn with the first in a series of debates mid-week. It is highly unlikely the Fed “fix” of forever QE will have an impact, but we may get a sense of what the Fed saw when they made their decision. There will be plenty of fireworks before the curtain closes on this year!
The third quarter ended in a similar fashion to how it opened: worries over economic growth and can the Fed help. However, unlike the start of the third quarter, stocks are within hailing distance of yearly and all-time highs instead of wallowing at the yearly lows. Given the built in expectations heading into the fourth quarter, it may actually be a good time to do some fall pruning. Momentum indicators are all at “over-bought” territory, indicating at least a few weeks of lousy market returns. One other characteristic that has been troubling of late has been the markets predilection for opening well and fading into the close. During September, the first hour of trading pushed the Dow higher 280 points, while the last hour declined just over 150 points. For the month, the Dow gained 346 points. A nugget for traders, but the decline in roughly two-thirds of the trading days closes has left a bad taste in investor’s mouths.
Bond investors have actually faired relatively well since the announcement of QE infinity, as long-term yields on Treasuries have declined by a quarter percent. The bond market seems to be playing some “what-if” over the past two weeks. What if QE is not successful in reducing employment (over which monetary policy can not directly control)? Investors may begin fleeing stocks and buy bonds. What if inflation cannot be fueled by intervention? The biggest fear of bond investors may not actually occur outside of dollar denominated commodities. The CRB, for the first time in over a year has just recently poked its head above the zero line for annual “growth”. Bond investors may actually be the biggest winners in the QE “gambit” instead of the expected stock market.
Using rather simple metrics for being in or out of stocks is still favoring stocks, as all asset classes remain above long-term averages. Now that QE is here again/yet and still, the expected beneficiaries have come up well short as energy, basic materials and industrial stocks have performed the worst over the past two weeks. The maligned utilities and consumer staples have joined bonds as the two-week winners. While maybe nothing more than a correction of the August/September trends, continuation of this trend could be worrisome for the overall market as investors seek safety ahead of the elections and impending fiscal cliff. Technology has been dominated by the likes of Apple (up 65% ytd) and Google (up 30% in third quarter). As a result, weakness in these two heavyweights will likely hurt various growth mutual funds in the fourth quarter. After a predominately one-way market during the third quarter, we’d expect to see the winners take a breather in favor of the more defensive names.
The under whelming response of the past two weeks to QE infinity may be a prelude to a much rougher fourth quarter than expected as the smooth sailing may have already occurred during the third quarter. Our original call for a short/shallow correction will be put to the test this week and may require more defensive measures if recent poor economic reports persist. Bond investors should note the fourth quarter has historically been the best over the past 35 years, with only five negative quarters (the last in 2010).
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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