Commentary for the week ending 4-16-10

Please note: Due to scheduling conflicts, there will be no market commentary next week.

The market trended higher for most of the week but fell sharply on Friday. For the week, the Dow rose by 0.2% and the S&P fell by the same amount, while the Nasdaq topped them both with a gain of 1.1%.

Source: MSN Moneycentral

The market finally had a strong pullback last Friday on news that the SEC will charge Goldman Sachs with security fraud. For over two months, the market has practically risen in a straight line upwards and we are actually reassured by the drop. After rising for so long without a correction, we believe the market has gotten ahead of itself, and it looks like other investors feel the same way. The news out of Goldman was not necessarily bad enough to send the market down over 1% in one day, but it gave investors an excuse to take some gains off the table. We are not sure if this is the beginning of a new leg down or if it was a one day event, but we are not committing any new capital to the market until we see how it plays out in the coming days.

Goldman Sachs lost over 16% at one point on Friday on the news. The story is certainly bad for Goldman, but we don’t see it being that bad. Without getting too technical, according to the SEC, Goldman Sachs created a product for trading that was based on subprime mortgages. An outside hedge fund apparently had input in the creation of the product and then went on to short it (profit when the value goes down), but Goldman sold it to investors who went long (profit when the value goes up, like a regular stock transaction). This is not illegal, but Goldman did not disclose the actions of the hedge fund to investors, which is illegal. Of course, the subprime sector collapsed and the hedge fund made a billion dollars, while the investors lost a billion dollars. What spooked investors was the fact that it is not known if other banks engaged in a similar practice and are also being investigated by the SEC.

The timing of the SEC announcement is also suspect, as financial regulatory reform is the hot topic in Washington these days. The actions of Goldman, or the rest of Wall Street for that matter, do not warrant further regulation, but merely enforcement of the laws that are currently in place. Further regulation would burden these businesses even further and serve no purpose, other than provide new talking points for politicians.

Several companies released earnings this week, and the results show that businesses are returning to profitability. Economic reports were mostly positive as well, reflecting the fact that the economy continues to improve.

Earnings season rolls on next week as more companies are scheduled to report. A busy economic calendar accompanies the earnings reports as leading economic indicators will be released Monday, the producer price index and existing home sales come in on Thursday, and durable goods and new home sales come in on Friday. It will be interesting to see how the market reacts in light of the drop last Friday.

Where are we investing now?

As mentioned earlier, we will not be committing any new money to the market after the drop Friday. We aren’t sure if that was a one day event or a new leg down and will be watching the market closely this week. If earnings continue to come in positive and the market improves, we will reevaluate our position at that time. Still, we are optimistic on the next several months, but remain cautious. The easy money and stimulative measures currently in place will help push the markets higher. Higher interest rates, higher taxes, increasing government involvement in the private sector, and a still-high unemployment rate have us worried for the longer term.

In equities, we are focusing on higher-quality and multi-national stocks. We continue to avoid banking and insurance sector stocks. Commodities remain a longer term favorite and we believe that government policies will weaken the dollar over time, despite its recent rise. TIPs continue to be important as we expect inflation to increase in the future, though the CPI report this week indicates little or no inflation at this time. U.S. treasuries are a sector we are very bearish (pessimistic) on as yields increase. Municipal bonds will play a more important role in our portfolios over the coming months and years as higher tax rates take effect. Finally, we are optimistic about international stocks, as emerging markets (excluding China) are areas we favor.

Several benchmarks hit new highs this week as the Dow crossed the 11,000 level for the first time in 18 months. At the close on Friday, the Dow sold off slightly to close just under 11,000, but was still up 0.6% for the week, while the S&P 500 gained 1.4% and the Nasdaq rose 2.1%.

Source: MSN Moneycentral

Masters week tends to be a quieter week on Wall Street, as many traders are preoccupied by the golf tournament. The stories surrounding the Masters this year certainly added to the attention, so it’s not surprising the volume was a bit light. When markets hit new highs, it is important to consider the volume of trades on that day. A high volume shows conviction while low volume does not show conviction. The new highs in the market and low volume this week don’t show us a conviction in the rally that we would like to see (although that probably can be said about the rally the entire past year).

As you can see in the chart on the right, the market has risen for two months without a significant pullback. While that may sound and look good, it is becoming worrisome to us. Markets don’t go straight up forever, and we worry that a correction may be coming. Trying to time the market is usually a losing proposition, but a rise this long without a pullback is keeping us on our toes. Besides, a healthy market doesn’t always go straight up. Pullbacks that spur more buying indicate a healthy rally and a conviction in the upward market.

The market had a modest sell off Wednesday, with the Dow losing over 100 points at one point. The Federal Reserve Bank of Kansas president, Thomas Hoenig, suggested the fed funds rate should be increased to 1.00% (it currently stands at 0%). The prospect of a rise in interest rates spooked traders who fear the easy money policies may soon be coming to an end. Hoenig stated that holding the rate this low for this long could cause a new bubble in the U.S. markets, a belief that we share. Nonetheless, the sell off Wednesday was followed by a rise in the markets Thursday and Friday. This is encouraging, but we would like to see the market sell off further before we commit to this rally.

Besides the stock market, other benchmarks reached new highs this week. Oil climbed above $87 per barrel, despite closing the week around $85. The 10-year bond yield rose above 4% this week, but also fell as the week progressed. Gold reached new highs for the year, as well. Despite the lack of volume this week, these rising benchmarks show the economy is improving as solid economic reports continue to be released.

The upcoming week marks the beginning of earnings season. Dow component Alcoa releases earnings on Monday and will set the tone for the week. Alcoa sold off strongly Friday after it was downgraded by JP Morgan, so it will be interesting to see how it fares once its earnings are released. Analysts predict that corporate earnings as a whole will rise substantially, so it will be interesting to see if the market pushes higher, or if the highs we saw last week are in anticipation of good earnings this week. In addition to earnings releases, several economic reports are on the calendar for next week, including the Consumer Price Index, retail sales, and housing starts.

Where are we investing now?

We saw a slight pullback this week, but the markets still pushed higher. We will be looking to see if solid earnings releases push the market higher from here. Stocks have risen sharply over the past two months and we would not be surprised to see a pullback in the near term. At any rate, we remain optimistic in the short term, but cautious. We continue to believe the easy money and simulative measures currently in place will help the markets higher. Higher interest rates, higher taxes, increasing government involvement in the private sector, and a still-high unemployment rate have us worried for the longer term.

In equities, we are focusing on higher-quality and multi-national stocks. Bank stocks should be avoided, as a troubling article in the Wall Street Journal showed they were hiding some of the risky assets from their balance sheet. We are still bullish (optimistic) on commodities and believe that government policies will weaken the dollar in the long term, despite its recent rise. TIPs continue to be a favorite, as we expect inflation to increase in the future, though benign at the moment. U.S. treasuries are a sector we are very bearish (pessimistic) on as yields increase. Municipal bonds will play a more important role in our portfolios over the coming months and years as higher tax rates take effect. Finally, we are optimistic about international stocks, as emerging markets (excluding China) are areas we favor.

Have a good week.

Another positive week for the major indices as the first quarter comes to a close. The markets were closed Friday for the Easter holiday, so as of Thursday, the Dow closed up 0.71%, the S&P 500 gained 0.99%, and the Nasdaq rose 0.31%. For the year-to-date, the Dow gained 4.8%, the S&P is up 5.7%, and the Nasdaq has risen 5.9%.

Source: MSN Moneycentral

Several economic reports released this week showed continued growth in the U.S. economy. The big story came on Friday, as the unemployment report showed significant gains in employment. In March, the U.S. economy gained 162,000 jobs and the unemployment rate remained unchanged at 9.7%. This number is less than the 190,000 economists anticipated, but remains a very positive report. Despite the additional jobs gained, the unemployment rate remains unchanged due to an increase in the labor force, another good sign. There was a worry that Census hiring would be the bulk of the gains, but these temporary workers only added about 50,000 jobs (nearly 1 million Census workers are expected to be hired over time). All-in-all, we are happy with this report.

A surprising news story that caught our attention came from the Obama Administration. In a week where oil closed above $85 per barrel, the Obama Admin announced much of the East Coast and Gulf of Mexico would be open for oil exploration. They correctly indicated that oil will play an important role in the foreseeable future and it can be drilled safely and cleanly off our coast. This is a reversal of his previous stance and we hope he truly means it. Our concern is that this announcement is purely political and may be part of a broader agenda for which he is seeking favor. We have to wonder why areas on the East Coast have been opened, but the Pacific Coast and parts of Alaska have been firmly shut. Only time will tell, but we hope this is a sign of the promised post-partisanship we have yet to see. A rising gas price will choke off this recovery and drilling in America would certainly be beneficial.

The upcoming week looks quiet in terms of economic reports; however, there are several items we will be watching. The futures market reacted favorably to the unemployment report on Friday, so we will be watching how the stock market behaves on Monday after investors had the weekend to digest the report. All indications point to a higher market, but nothing is ever certain when it comes to the stock market.

The mortgage market will also be in focus this week. Last week, the Fed ended its purchases of mortgage-backed securities which kept rates low in an effort to entice new home sales. We will be watching how the market reacts to this event over the next several days, though we have already seen a slight drop in activity, leading to higher yields. We are happy to see the free market take over here, but it may result in higher mortgage rates that cause a drop in home sales and a potential setback in the economic recovery.

Where are we investing now?

As the employment picture becomes brighter, we remain encouraged. The market has risen sharply the past couple weeks and we would not be surprised to see a pull-back in the near term. At any rate, we remain optimistic in the short term, but cautious. As we have said in past reports, the easy money and stimulative measures currently in place will help the markets higher. Higher interest rates, higher taxes, increasing government involvement in the private sector, and a still-high unemployment rate have us worried for the longer term.

In equities, we are focusing on higher-quality and multi-national stocks. We are still bullish (optimistic) on commodities and believe that government policies will weaken the dollar in the long term. TIPs continue to be a favorite, as we expect inflation to increase in the future, despite being tame at the moment. U.S. treasuries are a sector we are very bearish (pessimistic) on. Finally, we are optimistic about international stocks, as emerging markets (excluding China) are areas we favor.