Brief Selling Respite, Now What?
“Here comes the sun” might be the song to play after Friday’s market close. The week was certainly dark, with oil continuing to drop and a huge surprise from the Swiss allowing their currently to float. The “unpegging” of the Swiss franc currency reduced the constant buying of euros to maintain the exchange rate. The Swiss have been concerned about the cheap money implications on their economy and decided that maintaining the peg was no longer sustainable. The change by the Swiss also put pressure many on the hedge fund community that were borrowing francs at very low interest rates to invest in higher yielding securities. Once off the peg, the franc rose dramatically, forcing those that borrowed to repay a
much higher amount than the original loan. This “mini” financial crisis was seen as a realization that the Swiss could no longer support a ballooning deficit of their own. Ostensibly the other shoe will drop on Thursday at the European Central Bank (ECB) meeting. It is expected that the ECB will announce a US style quantitative easing, pushing additional funds into the European economy and pushing the Euro down further. Friday’s rally could be just a realization that parts of the markets have been pushed down too far or it could be merely a respite before the next wave of selling. The coming week should answer some of those questions, but will likely raise many more.
One characteristic of the market of late has been the pick-up in volume. As the market has declined, the volume has increased, indicating investor’s willingness to sell now and ask questions later. Compared to a similar period in December, volume is up roughly 4%. During the December period, the Dow fell by three percent, while the market has been flat so far in 2015. More importantly has been the volume on up vs. down days. Since last July, volume has generally expanded during down days and contracted on up days. Coupled with a very volatile investor sentiment reading, the volume measurements indicate an attempt to pick market tops. Each decline has been restricted to roughly 5% and the last 10% decline has been over three years ago. Any “prolonged” decline of more than three to five days has been met with a cry of “sell”. There seems to be much more “froth” in the Treasury bond market than in stocks, but risks remain for stocks. From strictly a seasonal perspective, the first quarter is likely to be weak, followed by a rally into the fall that could mark a peak for the market through the election in 2016. Volatility is here, but that doesn’t mean everything is falling apart. There remain some pockets of strength which are outlined below.
The Treasury market has been the safe haven investment, with yields pushed back well below 2% for a 10 year bond. While very low by US standards, it is very high compared to similar investments around the world. The Fed has announced they will be raising rates. The economic data indicates it should be soon. However, the inflation data indicates the increase should be postponed. Certainly the global economy (which the Fed does not really consider) remains uneven and generally weak. The continued volatility in stocks and external “shocks” like the Swiss move last week should keep investors generally buying Treasury bonds, keeping rates declining.
We have postulated that 2015 may not be the year of the SP500, and the early returns are certainly pointing to that possibility. Real estate, playing the role of income substitute is up over 7% already this year. International investing, whether emerging or developed, has bested the SP500 over the last few weeks. While the time frame is relatively small, the domination of the SP500 over many of the other indices for the past 4+ years was going to be hard to maintain. Friday’s rally was especially good for those parts of the market that had suffered this year, as energy and basic materials saw huge daily advances. It is too early to declare the energy decline over, but the relentless selling in those sectors will eventually abate and a violent rally could ensue. We will wait for more than just a day or two of good performance to declare a “bottom” in energy. For now, the group remains the worst among the SP500.
The primary focus this week will be on the ECB as they are set to announce “something” after their meeting on Thursday. It is expected they will be very aggressive in addressing a still moribund European economy, which could push the dollar higher vs. the euro. A failure to deliver on an aggressive move could push stocks down 1-3%, so volatility is likely to remain through the remainder of the month.
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.