Commentary for the week ending 5-14-10

Volatility is still high in the stock market as the major indices closed the week higher, despite the Dow closing lower in seven of the last nine trading days. At the close on Friday, the Dow rose 2.3%, the S&P gained 2.2%, and the Nasdaq was higher by 3.6%. Gold hit a new high this week, while oil dropped to a three month low.

Source: MSN Moneycentral

After taking a beating last week, the market shot higher Monday on news of a rescue package for the troubled European economies. The announcement of $1 trillion in aid was welcomed news since images of Greek riots had markets jittery after last week. The aid will come from a combination of European Union and International Monetary Fund contributions. Unfortunately, the U.S. is on the hook for over $60 billion, since we are the largest contributor to the IMF.

We had a hard time believing that throwing $1 trillion at the debt problems will solve anything. A debt problem simply cannot be solved by adding more debt. Tough, fundamental changes must be enacted to fix their ballooning deficit issues. To their credit, several countries have taken small steps to bring their debt under control. Time will tell if those measures were the correct remedy. For now, though, this aid package is nothing but a quick-fix that ultimately puts off the hard decisions until a later date.

As the week went on and investors had time to digest the news, it became clear that they were less enthusiastic about the rescue package, just like we were. The Euro fell to an 18 month low against the dollar. Gold rose significantly to new highs, which tends to happen when there are concerns about paper (fiat) money. Additionally, the markets sold off rather strongly on Thursday and Friday. The European debt issue may be with us for some time, so we are bracing for a more volatile market in the coming days and weeks.

Many positive economic stories were overlooked this week as Europe dominated the airwaves. Industrial production continues to grow, exports continue to rise, and retail sales came in higher than expected. All signs point to a recovery, but at this point, the market may have already priced this good news in.

Next Week

More corporate earnings are on tap for next week, with Walmart likely being the headline story. Several important economic reports are also due for release: Producer Price Index (PPI), Consumer Price Index (CPI), housing starts, and leading economic indicators. The minutes from the last Fed meeting will be released on Wednesday and it will be interesting to see if there was any discussion on raising interest rates.

Where are we investing now?

The market continues to be volatile, but this volatility also presents opportunity. Blindly buying on the dips might not be wise here, but opportunities have been presenting themselves and we look to capitalize on this. As we have said in past reports, we are optimistic through the end of 2010 since the easy money and stimulative measures 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. TIPs are important as we expect inflation to increase in the future, while U.S. treasuries are a sector we are very bearish (pessimistic) on as yields will increase over time. Commodities remain a longer term favorite, as inflation will also impact prices to the upside. Government policies will weaken the dollar over time, although we have been getting hurt on this trade recently with record drop in the Euro. 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.