It’s Never Happened Before – Or Has it?
Americans generally accept that the U.S. government has never defaulted on its debt before. Or has it? Pull out the history books and page back to 1790 where it is revealed that some payments were deferred. Even though the obligations were eventually paid, the episode was technically a default. In 1933, the government had debt obligations that were payable in gold but chose to pay with U.S. dollars, which were valued based on the price of gold when the bonds were issued instead of the fair-value price at the time of repayment. So yes, even though it’s a rare event, the U.S. has defaulted before.
However, just because it has happened before, does not make it acceptable then, now, or in the future. Unlike most entities that must somehow convince their lenders to help cover any short-term obligations, the government only needs to give itself permission to go further into debt. That limit, known as the debt ceiling, is what is garnering much of the headline news these days. The discussion is being complicated by political rhetoric, but since neither side of the aisle actually wants a default, there will likely be a palatable solution – even if it is a temporary one. The bipartisan “Gang of Six” moved everyone closer to that solution yesterday with a proposal that appears to be gaining some acceptance.
Meanwhile, the 10-year Treasury yield is still hovering below 3%, an indication that bond holders are assuming they will continue to receive their payments as originally promised. Instead of reflecting the possibility of default, bonds seem to be placing a high probability on continued economic weakness. Recent housing reports tend to reinforce that line of thinking. Housing starts were higher in June, but it was predominately due to a huge increase in multifamily units. In other words, rather than building and buying single family homes, the demand is favoring rental units. Whether the increase in rental demand is due to families not being able to afford a home or simply by choice (fear that housing prices have further to decline) is not clear.
Earnings season is underway once again, and most reports of the past week have come in ahead of expectations. The Technology sector seems to be providing much of the upside fireworks with better-than-expected earnings, and Energy related stocks have been bid up with the hopes that they will do the same.
Another event of the past week was the reported success of the so-called “stress test” on European banks. Only eight banks failed, which brought a sigh of relief, immediately followed by an outcry of skepticism. The results were released on Friday after European markets had closed, and when trading resumed on Monday, most of those markets established new four-month lows.
Energy surged from seventh all the way to first place this week. The most surprising part is that oil prices are at the same level today as they were a week ago, around $98. The strength turned out to be all equity related. Major integrated oil companies, as well as energy services firms, posted large gains on earnings expectations. About a month ago, it looked like the struggling Energy sector was breaking out below its four-month trading range. With the benefit of another month of data points, it now appears more like a widening of that trading range.
Consumer Discretionary weakened but dropped only one place to second while Consumer Staples narrowed the momentum gap and is holding on to third. Staples over Discretionary would appear to make more sense in this “jobless recovery” or whatever label you want to put on it. Then again, no one ever accused the market of being overly rational. Technology earnings made a lot of bullish headlines this past week and helped push the sector into the upper half of our rankings. Huge gains in the Tech sector have historically occurred when the semiconductor industry is providing the market leadership. We have a nearly opposite scenario now, with semiconductors being among the largest market laggards. We’re not saying Technology can’t perform well without the chip stocks joining in, we’re just saying it will be difficult.
Health Care slipped to sixth place this week as Technology and Materials moved ahead of it. However, the charts for the Health Care sector are still in good shape, and we wouldn’t get too concerned unless the June lows are violated. Financials continue to own the bottom of the rankings with most Financial ETFs establishing new lows for the year during Monday’s trading.
We can’t get a much clearer delineation between Growth and Value than what our rankings are showing today. Growth owns the top three spots while Value is relegated to the bottom three. Small Cap Growth still sits above all the others with Large Cap Growth and Mid Cap Growth close behind. Mid Cap Value flipped from positive to negative, and Small Cap Value is registering zero momentum. Somehow, the two capitalization extremes of Mega Caps and Micros Caps ended up next to each other in the middle of the pack.
The Global rankings are showing very little change this week. Perhaps it has something to do with the fact that currencies remained relatively stable the last six days. Japan held on to the top spot. ETFs focusing on the country are now at the high end of the trading range that was established in March when the first post-tsunami rally attempt met an abrupt end. For anything longer than an intermediate time frame, the charts for Japanese funds look dismal, making it hard to get excited about its current ranking.
The U.S. maintained its second place position. Canada edged up a notch into third place, helped by strength in the Energy sector and Canadian dollar (the primary exception to our earlier comment about stable currencies). Although many global categories got a bounce this week, the behavior across the Emerging Markets was much more subdued. We’ve discussed the four-month to six-month trading ranges that are now evident for many market segments, but it’s been more like nine months for the Emerging Markets. Additionally, those markets (including major players like China and Brazil) are closer to the lower end of their ranges than the top. Europe remains at the bottom of the list, which hopefully surprises no one.
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.
“In the broadest sense, monetary and fiscal policies have failed because government financial transactions are not the key to prosperity. Instead, the economic well-being of a country is determined by the creativity, inventiveness and hard work of its households and individuals.”
Lacy Hunt, Chief Economist, Hoisington Capital Management
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