Momentum in the stock rally stalled this week as the markets closed with mixed results. Through the close Friday, the Dow was slightly lower by 0.1%, its first negative week of the year. The S&P gained just 0.3% to make a new five-year high while the Nasdaq turned in a gain of 0.5% for a 12-year high. Gold saw little change on the week, falling 0.2%.
The two major types of oil took different paths this week. The North American crude (WTI) was lower by 2.1% to $95.72 per barrel. The international crude (Brent) continued to rise, closing just shy of $119 with a 1.9% gain. Since this international crude is used in much of our gas here in the east, prices at the pump continue to rise. The gas price increase was also aided by recent news of an oil refinery closing in the northeast.
The two major types of oil took different paths this week. The North American crude (WTI) was lower by 2.1% to $95.72 per barrel. The international crude (Brent) continued to rise, closing just shy of $119 with a 1.9% gain. Since this international crude is used in much of our gas here in the east, prices at the pump continue to rise. The gas price increase was also aided by recent news of an oil refinery closing in the northeast.
Source: Yahoo Finance
Though the markets closed the week with little change, they saw large daily swings as volatility returned. After the strong run-up stocks have had the last three months, it is only natural for markets to take a breather.
With that volatility, we’re seeing a tug-of-war of sorts between investors who think the market is due for a correction and those who think it should go higher (the bulls vs. the bears). This volatility often happens at inflection points, where the market trend changes direction. Only time will tell if the market will continue to trend higher from here or reverse course and head lower (we lean towards the latter).
There was very little news impacting the markets this week, especially in the US. On the other hand, news out of Europe picked up.
We have heard very little out of Europe over the last several months. Though badly needed reforms were never made to fix their problems, the panic subsided when the proverbial can was kicked. This has seen bond yields decline (which generally move lower on improving conditions) and the stock market to rise, similar to ours. Until recently.
Anxiety returned this week as political uncertainty reappeared. Political scandals emerged in Spain, banking scandals and election worries developed in Italy, and currency issues plagued the entire region. As a result, stocks turned negative on the year while bond yields rose.
The currency story was probably the biggest story of the week. Countries around the globe have been weakening their currencies, since a weak currency makes exports more appealing, thus increasing economic growth. Or so the prevalent thinking goes (though it ignores the fact that imports become more expensive and the cost of living generally increases. Otherwise the Weimar Republic or more recently, Zimbabwe, would have been successes).
With that volatility, we’re seeing a tug-of-war of sorts between investors who think the market is due for a correction and those who think it should go higher (the bulls vs. the bears). This volatility often happens at inflection points, where the market trend changes direction. Only time will tell if the market will continue to trend higher from here or reverse course and head lower (we lean towards the latter).
There was very little news impacting the markets this week, especially in the US. On the other hand, news out of Europe picked up.
We have heard very little out of Europe over the last several months. Though badly needed reforms were never made to fix their problems, the panic subsided when the proverbial can was kicked. This has seen bond yields decline (which generally move lower on improving conditions) and the stock market to rise, similar to ours. Until recently.
Anxiety returned this week as political uncertainty reappeared. Political scandals emerged in Spain, banking scandals and election worries developed in Italy, and currency issues plagued the entire region. As a result, stocks turned negative on the year while bond yields rose.
The currency story was probably the biggest story of the week. Countries around the globe have been weakening their currencies, since a weak currency makes exports more appealing, thus increasing economic growth. Or so the prevalent thinking goes (though it ignores the fact that imports become more expensive and the cost of living generally increases. Otherwise the Weimar Republic or more recently, Zimbabwe, would have been successes).
The US has been actively weakening its currency for this reason (which is ironic since we chastised China for doing the same). Other countries around the world are following suit. On Friday alone, Venezuela devalued its currency by almost half.
Most notably, Japan recently announced it was looking to weaken its currency and has dropped precipitously as a result (a 1-year chart showing Yen strength is seen right, courtesy x-rates.com).
This brings us back to the currency story in Europe, who has seen their currency rise in recent months. This is a concern for Euro leaders worried that they are at a disadvantage when it comes to exports.
The head of the European Central Bank (or ECB) mentioned they would take action to weaken the currency if problems appear. This sent the Euro sharply lower on the week.
All these countries racing to weaken their currencies have many believing we are in the early stages of a currency war and potentially a trade war. The Friday devaluation by Venezuela was just the latest salvo. While this race to the bottom may have short term benefits, nothing good will come of this in the long run.
Back to the news of the week, economic data was relatively light and leaned towards the negative side. Info on the strength of service sector showed a decline from last month, though still shows slight growth and productivity declined at a faster rate than expected.
On the other hand, the trade balance came in much stronger than expected, standing at its best level since 2010. Exports are up while imports are down, mostly explained by lower imports of oil.
Next Week
Next week looks to be even quieter than this week. Corporate earnings season is winding down while only a handful of economic releases will come in. We’ll get info on the strength of the retail sector, industrial production, and consumer sentiment. A few regional Fed presidents will also make speeches, which is always interesting to get some insight into the Fed.
Investment Strategy
No change here as the market still looks expensive. We think the market is due for a correction, but trying to successfully time the market can be a fool’s game. We hate to miss out on further upside, so it doesn’t hurt to add some downside protection. Buying cheap puts (which allow us to be protected from downward moves while still participating in the upside, minus a cost, of course) looks to be a play at this time.
As for the negatives we see, we don’t think economic growth is as strong as perceived. In fact, this is the worst economic recovery since the 1940’s. Corporate earnings are poor in absolute terms, though they still beat the extremely low expectations. We may be headed the right direction, but it sure is slow.
Plus, we will have drama out of Washington returning in the coming weeks with the sequester and government funding fights.
The one positive we see for stocks is the Fed. We believe the money printing by the Fed has been the biggest driver of the stock rally. And since the beginning of the year, they have been printing even more. While it hasn’t shown to help the economy much and will have negative long term consequences, it does send stocks higher in the meantime.
Will stocks keep going higher as the Fed keeps printing? It certainly helps. But when everyone is as optimistic on the market as they are now, we become even more cautious.
While we aren’t looking to do any buying in the broader stock indexes at this point, we are always looking for opportunities. In individual stocks, we still like higher-quality and dividend paying ones. Companies with operations overseas have seen better earnings than those who don’t. We also like smaller and mid sized stocks that don’t have a strong correlation to the broader market and Europe.
Gold has done little in recent months, but we still like it for the long term. Central banks continue to print money to stimulate their economies and weaken the currencies, a condition that favors gold. We would look to add to our positions if it goes much lower from here.
We like other commodities for the long term, especially due to weaker currencies around the globe. A slowdown in global growth may weigh on commodity prices in the short run, though.
As for bonds, Treasury bond yields are higher than their recent average (so prices have fallen). A short position (bet on a decline in price) has done well here. However, we worry that this is unlikely to continue, making the short position only a nice hedge. The potential for longer term profit is low at this time.
We also think TIPs are important as we still expect inflation to increase. Municipal bonds provide a nice way to reduce taxes, though new itemization laws may reduce their benefits in some cases.
Finally, in international stocks, we are less enthusiastic on developed markets, but not totally sold on emerging, either.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
