06/26/13   A Simple Misunderstanding

Editor’s Corner

Ron Rowland

The Federal Reserve would like you to believe it is flexible.  Five weeks ago, Ben Bernanke attempted to demonstrate flexibility by saying the tapering of bond purchases by the Fed could begin as soon as the June or July FOMC meetings.  The market didn’t enjoy that particular brand of flexibility and started to decline.

Last week, Mr. Bernanke sought to calm investor fears.  Believing that his comments in May were misunderstood, he said the Fed’s current estimate is that tapering will begin late 2013 or early 2014 and be complete in mid-2014.  Any tightening of interest rates would likely not start for another year after that (two years from now).  These particular timetables are dependent on an economy that continues to improve, and any economic weakness could delay these events.

Instead of reassuring investors, last week’s attempt to clear up the misunderstanding caused the market’s previous slow decline to accelerate to the downside.  For some reason, learning that tapering would not begin immediately did nothing to placate investor fear.  However, a mid-2014 completion date was apparently not expected.  A six-month long withdrawal process seems to be perceived more like cold-turkey than tapering to those addicted to Fed stimulus.

This week, Fed officials are at it again, trying to clear up the market’s misunderstanding of last week’s cleanup attempt.  Narayana Kocherlakota, Minneapolis Fed President, argued the Fed is committed to its bond-buying program until the unemployment rate falls further and to keeping interest rates near zero for a long time after that.  New York Fed’s William Dudley repeated his view that the program has not accomplished its goals yet and the economy still requires easy-money policies.  Dallas Fed President Richard Fisher reminds us the Fed hasn’t done anything yet.  “We’re not talking about an exit.  We are talking about dialing things back,” he told reporters in London.

The Department of Commerce tried to do its part in clearing up the misunderstanding today.  It revised first quarter GDP downward from 2.4% to a 1.8% annual rate.  The market seemed to like the bad news, as it implies tapering is unlikely to be imminent.  Perhaps Mr. Bernanke would have been better off not saying anything back on May 22 and just letting the economy speak for itself.

Investor Heat Map: 6/26/13


There wasn’t any noticeable sector rotation this past week.  The top-ranked sectors are still on top, and the lower-ranked ones are still on the bottom.  Instead of rotating, everything weakened.  Last week’s relatively healthy mix of nine positive trending categories and only two negative ones has been cast aside for just four positive and seven negative sectors today.  Additionally, the few remaining positive categories appear vulnerable.  Consumer Discretionary is still in first place, reminding us that consumer spending is an important part of the economy.  Health Care, Industrials, and Financials round out the top four, the same as they did a week ago.  The bottom four are also identical to last week’s ranking.  Materials, Utilities, and Real Estate are all registering significant downtrends.


Don’t bother looking for any changes in the relative strength of the Style categories because there aren’t any.  Changes in absolute strength are a different story, as selling walloped all eleven categories this past week.  The complexion of the rankings changed dramatically with all categories having positive trends a week ago, while only five can say that today.  Positive market action of the past two days is trying to reverse these slides before they pick up more downside momentum.  Micro Cap is still the overall leader, followed by Small Cap Growth and Small Cap Blend.  Mid Cap Value is in last place with Large Cap Growth only slightly better.


As bad as the Sector and Style charts look today, the Global rankings look worse.  Every major category we track has a negative momentum reading today.  The U.S. still sits at the top, making it the best of a sorry lot.  Strong gains in the U.S. dollar created further hardships for international holdings, pushing them deeper in the red.  Japan climbed up a notch to second place.  Volatility in Japanese stocks is making U.S. stocks appear very calm by comparison.  Europe had a nasty week as stocks lost about 5% and the Euro dropped another 2%, combining for a 7% decline as viewed from here in the States.  The U.K. and EAFE hold their spots in the middle of the lineup.  Below them, things are starting to get ugly.  Pacific ex-Japan, Emerging Markets, and China have suffered severe declines, although they are still able to show a small positive return for the past twelve months.  Latin America cannot make that claim.  Stock prices there have reverted back to their July 2009 levels.


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 paints a picture of an economy with clearly less growth momentum at the start of the year than previously suggested.”

Peter Newland, economist at Barclays, reacting to the downward GDP revision (6/26/13)


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