Bernanke’s Plan, or Lack Thereof
The short-term uptrend in domestic stocks is still in place. The S&P 500 quickly moved to the high end of its summer trading range after being on the verge of falling through the low end just two weeks ago. On the cusp of breaking out to the upside, a failure to do so at this point would signal the market is still locked in a broad trading range. Many other benchmarks have similar patterns, with only the Nasdaq showing a definitive breakout to the upside.
The big news this week is Ben Bernanke’s semiannual testimony to Congress, which was conveniently preceded by an editorial under his name in the Wall Street Journal. In both forums the Fed chairman outlined how he intends to reverse the current easy-money policy when the economy recovers (also known as the Fed’s Exit Plan). Commentators have made much of Bernanke’s plan, or lack thereof, but we’re not sure he said anything new. It is not a news flash that the Fed thinks the economy is weak and could potentially get weaker. Everyone knows they will have to tighten up at some point. No one, not even the Fed, knows when that time will come. The market is aware of the various policy options that will be available whenever it is time to act. Bernanke’s goal this week may have more to do with keeping political noses out of the Fed’s business along with getting himself re-appointed next year.
Corporate earnings news for the second quarter is hitting the wires at a furious rate. The bottom line has been impressive thanks to aggressive cost-cutting, but top-line revenue trends are dismal at many companies. Coca-Cola (KO), Caterpillar (CAT), Dupont (DD) and United Technologies (UTX) all missed their revenue forecasts by substantial margins. Consumers are cutting back and businesses of all kinds are contracting, not growing. How this adds up to higher stock prices is not entirely clear to us. Once the fat is gone, at some point sales will need to grow.
Last week we mentioned that CIT Group (CIT) was hoping to be bailed out of looming bankruptcy. The powers-that-be in Washington apparently decided not to ride to the rescue. Lo and behold, the company’s bondholders came together and agreed on their own plan to save the company. This is the way it is supposed to work. CIT lives, its staff is still employed, its creditors have a chance to recover their capital, and the taxpayers are not being pillaged. A similar decision appears to have been reached at the federal level regarding California’s dire financial situation. In that case it was legislators rather than bondholders who were in a logjam but have now reached a compromise. Perhaps the expectation of endless bailouts is beginning to fade. We suggest similar policies be applied to Goldman Sachs (GS) and JP Morgan Chase (JPM).
Treasury yields moved lower on the Bernanke testimony. After jumping from around 3.3% to 3.7% in five days, the ten-year Treasury ended today at 3.55%. Long-term interest rates are fluctuating based on inflation expectations, which have risen dramatically since December. It is hard to believe that only seven months ago the ten-year yield almost dropped below 2% in near-panic economic conditions. We won’t rule out a replay, but for now rates appear set to stay quite a bit higher.
The Materials sector made a huge advance of nearly 15% in the last two weeks and accordingly climbed from #7 to #2 in our momentum rankings. Technology still holds the top spot. Consumer Discretionary moved into third place. Telecom is now at the bottom of the list as Energy moved up a notch and Industrials jumped. The biotechnology sub-sector of Health Care surged this week after a company called Human Genome Sciences (HGSI) revealed successful clinical trials for a new lupus drug and also new orders for its anthrax vaccine. HGSI is up about 450% so far this week (no, that’s not a typo), enough to push most biotechnology funds significantly higher.
All the Style categories are in the green once again as Large Cap Value and Small Cap Value regained some momentum. The pecking order is still growth over value. Relative rankings had only minor shifts, but all the categories showed substantial improvement in absolute terms.
Japan had a positive return for the week but plunged from fourth place to last as other markets jumped even more. Two weeks ago we mentioned that Japan’s strong relative strength was more of a “less weak” phenomenon. The rebound around the globe since then was much stronger than the bounce in Japan. The order of the top three world markets is unchanged: China still has a lock on the top, followed by Emerging Markets and Pacific Ex-Japan. The Materials sector rally helped Latin America and Canada climb higher.
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.
“But why, some say, the moon? Why choose this as our goal? And they may well ask why climb the highest mountain? Why, 35 years ago, fly the Atlantic? Why does Rice play Texas?”
John F. Kennedy
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