Has the Rally Run Out of Steam
“May you live in interesting times,” goes the ancient Chinese curse. The past nine weeks were nothing if not interesting for investors. Market sentiment went from utter despair to joyful glee. You might even call it “irrational exuberance,” given that Alan Greenspan now thinks the worst may be over. From the March 9 low, no pullback in the S&P 500 has lasted more than two market days – until today, which marked the first three-day correction in ten weeks. This does not necessarily mean more losses are coming. This astonishingly resilient rally handily took out one resistance level after another. Enough buyers were convinced to move the benchmark from extremely oversold to extremely overbought in a matter of weeks. The 200-day moving average, which as of today stands at about 949, is the next line in the sand. Our best guess is that it will take a period of consolidation before the index can take that step – and a significant correction is quite possible. For now, we remain in a very risky bear-market rally.
The latest economic buzz phrase is “green shoots.” We apologize for repeating it here if you are already tired of hearing it. Nonetheless, the term is evocative. Even the lushest tropical plants begin life as tiny leaves peeking above ground level. As any farmer will tell you, the mere presence of green shoots is no guarantee of an abundant harvest. Plenty of things can go wrong: a late freeze, an extended drought, disease, locusts, and so on. Green shoots are a necessary but insufficient condition for market recovery.
One widely-touted green shoot has been a consumer spending resurgence, but it seems the locusts have not gone away. Retail sales dropped -0.4% in April, and the previously-reported March figures were revised downward. The loss was led by declines in electronics, furniture, clothing and grocery stores. Gasoline sales dropped amid higher fuel prices, indicating that Americans are driving significantly less. Retail sales were down even if the troubled automotive sector is excluded. General Motors (GM) shares dropped to their lowest price since 1933 as bankruptcy now appears certain.
As we keep saying, retail sales are down because unemployed people do not spend money unless absolutely necessary. While there are signs that the pace of layoffs may be slowing, there is zero indication that the private sector is creating new jobs for the millions of unemployed. The most active part of the labor market right now is the federal government, which is hiring thousands of extra people to help with next year’s decennial census. The Census Bureau is reportedly getting hundreds of applicants for each open position.
Given all this, we find it hard not to be cynical about the “stress test” that was easily passed by all of the 19 largest banks last week. The results reveal that there really was no test at all. The “adverse” scenarios were barely worse than what we already face. The banks essentially graded themselves, despite the fact they have already been proven totally incompetent in credit analysis and risk management. The whole exercise appears to have been nothing more than a set-up for the next round of bailouts. The banking crisis is far from over.
The 10-Year Treasury yield ran up to nearly 3.39% last Friday but has now returned to the 3.1% area. The jump in yields seems to have been sparked by a belated realization that the growing government debt will eventually be monetized and create inflation. Not coincidentally, gold is back above $900 and crude oil is flirting with the $60 area. Rising commodity prices and a plunging U.S. dollar suggest that inflation may become a concern sooner rather than later.
After weeks of expansion, we are starting to see compression in our rankings. The range between the highest and lowest-ranked sectors dropped to 72 from 96 last week. This is partly due to sector rotation: the recently-weak “defensive” sectors like health care, consumer staples and utilities are picking up momentum while the aggressive technology and consumer discretionary stocks are pulling back. Health Care has been particularly interesting, showing a gain for the week-to-date period while most of the market has been in a three-day retreat. Financials are still trending upward, but their volatility is off the charts. Daily swings of 5% or more are becoming common in the once-stable SPDR Financial ETF (XLF).
As with sectors, the style categories are becoming more compressed as well. The range from highest to lowest RSM is now 22, down from 43 a week ago. This appears to be another form of rotation, with the previous momentum leaders losing strength and the laggards picking up speed. Mid Cap Growth lost the most momentum but remains on top of the list, while Mega Cap rose the most in absolute terms but is still last on the list.
The strength in commodities shows up well in the Global Edge chart. Oil, gold, and agricultural goods are all rising in value, lending support to resource-intensive markets like Canada. The resulting decline in the US Dollar gave a boost to every global market except the US. Latin America regained the top spot, Canada moved up into third place, and even Japan moved ahead of the United States, leaving Uncle Sam on the bottom of the list.
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.
“All the perplexities, confusion and distress in America arise, not from defects in their Constitution or Confederation, not from want of honor or virtue, so much as from the downright ignorance of the nature of coin, credit and circulationfavors the informed mind.”
John Adams (1787)
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