Efficient Market Hypothesis Takes Another Hit
While America enjoyed the spectacle Tuesday of one unpopular group (senators) grilling an even less popular group (Goldman Sachs executives), the real news was coming out of Europe where the debt drama appears to be reaching its final stages. Interest rates of two-year Greek government debt spiked to more than 25% this morning as default began to look more and more certain. We have maintained throughout this crisis that European leaders would delay as long as possible before taking any meaningful action. The bond market is now forcing their hand. A downgrade of Spain by S&P increased the panic as the worst fears of a spreading debt contagion began to be confirmed.
World equity markets sold off on the news, with the iShares MSCI EAFE ETF (EFA), which tracks the widely followed Europe, Australasia, Far East international benchmark, having its second-largest one-day decline in more than a year. U.S. benchmarks took their biggest hit since February. Volatility measures, which had been near multi-year lows at the beginning of April, surged higher with the widening fear. This is an excellent illustration of how irrational markets can be. Everyone knew about Greece’s problems but still reacted with surprise, proving once again the Efficient Market Hypothesis is only a hypothesis.
The Federal Reserve meeting today ended with no policy change and yet another pledge to keep rates “exceptionally low” for an “extended period.” Bernanke and his associates actually have few other choices. With unemployment high, credit tight, and huge government deficits, raising rates would have been foolish. The U.S. is in some respects a beneficiary of Europe’s turmoil. We have our problems but on a relative basis are still the best available choice. This is why the dollar is climbing against other currencies, especially the Euro. It is also why both short-term and long-term interest rates are staying near historic lows. The Treasury is still having no trouble selling as much debt as it wants. The ten-year yield ended today at 3.77% and appears to be entering an intermediate-term downtrend.
Given all this, Wall Street is actually doing quite well. Goldman Sachs still faces long-term problems but escaped from the Senate hearings mostly intact, consumers are gaining confidence, the economic recovery is plodding along, and corporate earnings have been impressive. The trends will change at some point, but for now most of the lights are green.
Some sectors still managed to gain momentum despite an overall negative week in most equity markets. Consumer Discretionary, Industrials, Energy, and Utilities all tacked a point or two onto their momentum readings even as the average sector dropped five points. Consumer Discretionary is still on top. Financials fell, allowing Industrials to move up into second place. Health Care had a terrible week and fell into last place and a negative intermediate-term trend. The Europe-related flight to safety in some assets is not helping the defensive sector trio; Health Care, Utilities, and Consumer Staples are still at the bottom of the scale.
The week brought no change in the relative Style rankings, but the spread in momentum readings became even larger. More than 50 points now separate Micro Caps on the top from Mega Caps on the bottom. The top three categories all increased their momentum while the bottom eight saw a decrease. In other words, the weak are getting weaker as the strong are getting stronger. For the second week in a row, we see the rare situation of Micro Cap and Small Cap Value having higher readings than all the sectors and geographic areas.
North America is currently home to the best-performing equity markets. The U.S. and Canada own the top two spots in our global rankings. Meanwhile the bottom three categories all flipped into negative trend territory. Not surprisingly, Europe was hit the hardest as stock losses were aggravated by a declining currency. China continues to struggle. The developed world ex-U.S., i.e. the EAFE index, was pulled down by its large exposure to Europe. Japan jumped in the rankings as it “fell less” than other markets.
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
“It could have been more accurate.”
Fabrice “Fabulous Fab” Tourre
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