Finance, Insights

China Weakness is US Market Gain

PaulNolte-2Ben Bernanke, former Chief of the Federal Reserve has moved to the dark side, accepting positions with Citadel in Chicago and PIMCO as senior advisor. Citadel has been involved with high frequency trading, where ultra fast computers rapidly buy/sell securities. PIMCO has lost their founder, Bill Gross, to Janus Capital late last year. So why is Bernanke making the move to the private sector? Certainly these companies have been beneficiaries of the Fed’s low interest rate policy over the years. While neither firm is under the Fed’s regulatory arm, it continues a very long tradition of those in public service “cashing in”. It also maintains the very entanglement between the financial industry as a whole and in a broad sense, those in charge of overseeing the industry. His first entanglement after joining the two firms was to write an op-ed piece in the Wall Street Journal defending Fed policies during his tenure and pointing a sharp finger at those critics who also were wrong in the outcomes of Fed polices of the past six years. The “science” of high finance is getting a look under the microscope of late. What we are seeing isn’t all that pretty either!

Recently, we highlighted the possibility of a forthcoming correction. While the past week hardly qualifies as a correction, the underlying figures were a bit more disconcerting. This signals the possibility of further weakness ahead. While stocks were modestly lower on the week, the net number of declining to advancing issues was the fourth worst over the past seven months. This was true in the OTC market, where the spread was the worst of the year. According to various investment sentiment readings, investors are very bullish about the stock market. However, when looking at the day-today trading, there is much more volume (activity) on down days than when stocks rise. The worst trading day in over a month came on one of the highest volume days all year. This week will be loaded with economic data that could point to not only the direction of the economy, but the Fed policy. It is anticipated the employment report will resume its strong performance of the past year, reversing the weakness of last month. IF wage growth improves, it also increases the likelihood of a Fed increase in rates sooner rather than later.

Unlike the Wall Street phrase of selling in May and going away, for bond investors it is best to buy in May. Over the last forty years, the worst part of the bond market “year” is from February through May. Even this year, bond prices fell in February and April. The bond model has once again turned negative on the heels of higher commodity prices, led by energy. Utilities and REITs have also declined in price as investors “ready” for the inevitable increase in interest rates that the Fed has threatened for the past nine months. In fact, the two year bond has nearly tripled from the low of two years ago, so rates have already been rising. Granted, it is from extremely low levels, but rates have been slowly and steadily increasing well in advance of any Fed movement in interest rates.

As highlighted above, the interest sensitive parts of the markets are beginning to show stress. From the REITs to utilities to even higher yielding consumer stocks, the fear of higher rates is beginning to impact stock prices. The other side of the market, the long neglected energy sector continues to improve. While gas prices may not get back to the $100/bbl they were selling at last summer, the gradual improvement has gone unnoticed by investors. Worries about still declining oil rigs and a flood of energy in the markets have masked the improvement in the stock prices of many of the oil companies. Over the past four months, energy stocks are the best performing sector of the SP500 (up 9%), with former darling healthcare toward the bottom (up 3%) and utilities (down 8%). During that same time the SP500 rose a modest 4%. Even the dollar and international markets have noticed. The dollar is down roughly 5% from its peak, while international investments are up roughly 10% already this year. It has always made sense to be a global investor. However, the rewards for doing so did not accrue over the past five years. We are now beginning to see that change.

All eyes will be on the jobs report on Friday, but we’ll also be keeping an eye on how the markets trade during the week, as cracks are beginning to show up that may point to lower stock prices in the weeks ahead. Since the economy is not yet looking like a recession is at hand, any market decline is likely to be modest and maybe a buying rather than selling opportunity. Bond investors may see higher rates during May, but the roughest part of the year has likely passed. Even so, short-term bond yields could continue to rise gradually in the months ahead as they anticipate a Fed tightening.

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.