Nolte Notes for the week of October 15, 2012Paul J. Nolte - Monday, October 15th, 2012
One of the more overused lyrical “hooks” of the past three years has to be “how you like me now?” from The Heavy, which sells everything from cars to beer. The world of finance uses the hook regularly too, from money managers to companies releasing earnings. Last week, banks were in the spotlight, from record setting earnings at JPMorgan to a lawsuit against Wells Fargo. In a separately released report, the office of the Comptroller of the Currency indicated derivatives are larger now than at the height of the crisis. The economic data remains mixed at best, with exports falling, creating a wider trade deficit and producer price inflation is higher than expected. Jobless claims were lower and inflation without food/energy was a smidge higher. Internationally, Spain debt was cut to near junk status and Chinese loan growth was also below expectations. So how you like me now? Judging by the financial markets response last week, not so much. Bank earnings, China’s economic growth, Presidential debate 2 and existing home sales will keep the markets hopping to the beat all week long.
The poor showing by the stock market last week was its worst since late May. Many of the weekly (long-term) indicators that have been rising throughout the summer are beginning to turn lower. One indicator that has been feeling the markets pain for a while has been the first/last hour trading indicator. The first hour of trading usually captures the knee jerk reactions to global news overnight and/or economic data released before the open. The indicator looks at the negative (and emotional) reaction to bad news as a positive. The indicator then adds the final hour of trading. When investors feel good about the market and want to hold investments over night, they will push stocks higher. Since the end of July, the markets have generally opened higher and closed lower to the tune of 1600 Dow points. The Dow is up a mere 300 points over the same period. While not an immediate warning of doom, this indicator is more a signal the internal health of the market is weak.
Bonds are once again in the spotlight, as the bond model improves one notch with treasury and corporate yields falling (and prices rise). In their attempt to boost “risk assets”, the Fed’s quantitative easing policy has actually been a boon to bond investors since the announcement. The actual market reaction is very different than that of the prior initiatives. After all the “shock and awe” of the past three years, investors are not so shocked and merely say awe. Commodities, the usual beneficiaries of Fed action as the dollar declines, have not had the same reaction. After falling since late July, the dollar is actually higher now than when the new QE policy was announced last month. Commodities have also declined over the past few weeks and remain roughly equal to last year’s level. This is a very different reaction from bond and equity investors to the Fed’s policy, one that requires a good defense rather than offense.
As indicated above, the financial markets have been reacting very differently to the latest round of QE policy by the Fed. Bond have rallied, stocks declined and the best place to hang out in the equity markets have been the staples and utilities, while technology and materials have suffered the most. One inexpensive sector that is still selling for below market multiples is the tech sector. The sector has not performed well over the past few weeks, likely as a result of their huge international exposure. Their international exposure is seen as a negative as a higher dollar hurts their overseas earnings. Other markets, like small cap, real estate (REITs) and even the SP500 are getting perilously close to crossing below long-term average prices that would be read by many as a technical sell signal. Poorer than expected earnings reports in the weeks ahead along with slowing economic data from China could be enough to push the equity markets lower and put in place something more than a short/shallow correction that has been anticipated.
My expectation for another market rally on the heels of another QE policy looks to be incorrect. Although the markets are entering the best portion of the year, equities could be a turkey this fall while bond investors celebrate at yearend. As a result, a more defensive posture needs to be taken for equity investors, while bond investors may be rewarded for being more aggressive.
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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