We’ve Passed This Way Before

PaulNolte-2The full moon has been a source of mysticism and wonder since ancient times. It has been linked to higher births (just ask a pediatric nurse), more arrests or just plain strange behaviors. It may also explain the nearly 4000 point trip that the Dow took last week as fears that China would be nearing/falling into a recession grew after two devaluations of their currency. The weekend did not calm fears and the markets opened down over 1000 points rather quickly. By the end of the week, the major averages were actually up for the week, leaving pundits scratching their collective scalps wondering what just happened. Could this be the beginning of something bigger or just another computer generated frenzy that signifies nothing? The economic data in the US remains good, and likely good enough to warrant a rate hike by the Fed in September. Global data is OK as well, not scorching hot nor recessionary. But everyone is wondering what is behind the Chinese curtain, the grand wizard or a mere mortal pushing and pulling levers that are not connected. There may be the opening act of a very interesting global economic play that most assuredly will have a surprise ending.

As highlighted last week, many of the indicators we look at within the markets, from net number of advancing to declining stocks, investor sentiment and various momentum indicators were getting to territory that would indicate a bottom for the market would be close at hand. Monday’s huge opening drop likely marked the short and maybe intermediate bottom of the market. History would say that we likely experienced a momentum bottom and a typical bounce that recaptured half of the decline from the recent peak in late July. We would expect volatility to remain as the markets sort out the heavy economic slate this week, more news from China and debate whether the Fed will raise rates. It is likely that the market declines a bit as some very short-term investors take recent gains off the table, while others sort through the mess of the last two weeks. Even though the averages finished higher on the week, more stocks fell than rose and the focus was once again on the largest names in the index. If we could ignore the movements during the week, it was not much different than many of the recent weeks. Based upon the trading activity for the week, it looks as though most of the action was between computers rather than individual investors rearranging portfolios. The next few weeks should settle down, but may do so in an interesting way!

The relationship between stock and bond returns peaked with Tuesday’s disappointing stock decline in the last two hours of trading. The spike in relative performance has mirrored that of January and last October. The question is whether this event is merely another bad week or two that ultimately gets reversed as investors go back to buying stocks and shunning bonds? The quick recovery in stocks as bond yields rose a bit later in the week might suggest yes. Further, the bond model has moved to negative territory as utility stocks took it on the chin last week. The events in China have convinced investors that a rate hike will be pushed back to December, as short-term Treasury yields were cut in half last week. They had increased to their highest level in two years expecting a rate hike soon. Does the Fed lead or lag the markets? We shall find out in a few weeks when the Fed meets on the 17th and 18th of September.

It is always assumed that there is something doing well at any given point in the market. When all is crazy there is one decent asset class that can weather the storm. By Friday’s close, there was not one major asset class that was trading above its long-term average, which is a polite way of saying cash, at zero percent return, is doing better than everything else. Bonds have provided a positive return this year, however it all came in January and prices have declined ever since. Only in relationship to stocks do bonds look good. Based upon the huge market declines around the world over the past three weeks or so, we are expecting markets to sort themselves out and once again “act rationally”. Within the US markets, the various sectors have not changed in their rankings. Here too, a few weeks more of trading may show some new trends developing.

We raised some cash over the past few weeks and have redeployed some of it into other parts of the markets that may be insulated from the international “issues” that have rankled markets around the world. Some individual stocks and sectors are beginning to look good after being out of favor for quite some time. Bond investors should keep maturities relatively short, expecting that the Fed raises rates in September. Not because they need to, but they have been promising for so very long!

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.