Commentary for the week ending 10-1-10

The markets ended their winning streak this week as the major indices were slightly lower. For the week, the Dow fell 0.3%, the S&P 500 was lower by 0.2%, and the Nasdaq was off 0.4%. Commodities continue to soar due to a weak dollar, with oil closing above the $80 level and gold notching further record highs.

Source: MSN Moneycentral

This week also marked the end of the month and third quarter. Historically, September is a tough month for the markets, but this year was different. With a gain of about 8%, the Dow had its best September since 1939. Sentiment was extremely negative in August, so many investors (including us) were preparing for another rough month in September, only to be wrong. This just serves as a reminder that the market typically does the opposite of what most people think it will do.

Despite these gains, the volume of trades remains very light. Sentiment is improving, yet investors continue to pull money out of stocks. To make matters worse, corporate insiders continue to sell their own company stock. This week, for every one insider buying, roughly 1400 were selling (a 1400-1 ratio). Following insiders is not always a foolproof strategy, but an indicator investors should consider.

Commodities continued on their tear this week. In the chart on the right provided by the Wall Street Journal, you can easily see the run commodities have been on (the DJ-UBS Commodity Index is a composite of different commodity sectors) We are seeing the inverse relationship between commodities and the dollar really pick up (as the dollar falls, commodity prices climbs). With the Fed telegraphing a weaker dollar in the future, it is possible for commodities to continue this climb.

The rationale behind a weaker dollar is it is intended to promote US exports. Since the dollar is worth less, other countries will find our goods cheaper and subsequently purchase them. This causes a problem, though, that we are already beginning to see. Other countries want their exports cheaper, as well, so they will try to weaken their currency. This turns into a race to the bottom and fuels a trade war. Several countries have already started down this road of a weaker currency. Japan, most notably, but also Taiwan, South Korea, Thailand, Peru, Brazil, Columbia, and much of Latin America.

The US is becoming more protectionist over a perceived weak Chinese currency, and we are seeing similar rhetoric around the globe. Major exporters like Brazil are complaining that these cheap currency interventions are unfair (even as they try to weaken their currency). We are becoming increasingly concerned a global trade war will occur, and we will ultimately all be the losers.

Next Week

Next week will be a busy one as we will be receiving data from September and the third quarter. Of particular interest is the unemployment rate release on Friday. We would like to see an improvement to convince us that a recovery is indeed underway.

Third quarter corporate earnings releases will begin next week, as well, so there will be plenty of info to move the markets.

On a different note, we are interested in the IMF/World Bank meeting next week in Washington. With all the currency concerns around the globe, it will be interesting to see the rhetoric that comes out of this conference.

Where are we investing now?

Similar to September, October is fearful month for the markets. However, the recent rise makes us more confident in a rise through the end of the year. See, professional investors have largely not participated in the recent rise and are underperforming their benchmarks. In an effort to “catch up”, they will be more aggressive in purchasing securities and stock prices will rise accordingly. Combine this with the Fed pumping up stocks, and you have a recipe for a market rise.

There is still a considerable weakness in the economy, though, and we would wait for a pullback before making any considerable positions. There are many headwinds, too, like higher future taxes, increasing government involvement in the private sector, and a still-high unemployment rate, which continues to worry us.

In equities, we are focused on higher-quality and multi-national stocks, but some smaller stocks look promising, as well. A weak dollar would be a plus for export-oriented companies. 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. We are finally starting to see this position go our way as bond yields have risen recently.

Commodities remain a longer term favorite, as mentioned above, as inflation will also impact prices to the upside. 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.