Time for a Nap
Investors of a certain age recall a slower, more relaxed time when obscure news stories didn’t flash into every home at the speed of light, when the closing bell actually meant trading stopped, and when holding periods were measured in months instead of milliseconds. That world is not coming back, nor do we wish it to do so. Nonetheless, the mood swings currently evident in the stock market are troublesome – and not just for nostalgic reasons.
While information moves faster than ever, human minds are still vulnerable to excessive elation as well as anxiety. Hence, we see a market moving from crisis to panic to relief to euphoria within the space of a few weeks, based on nothing more than short-term data points and the expectations game that surrounds them. Investors who fear the train is leaving the station without them leap into action without much forethought. Benchmarks move too far, too fast. The resulting corrections and consolidation should surprise no one.
Consider corporate earnings. For months, we have said that cost cutting would only take companies so far without top-line revenue growth, the prospects for which are questionable at best. This morning Mohamed El-Erian, co-CEO of bond giant PIMCO, said essentially the same thing. El-Erian went on to say the market seemed to be on a “sugar high” after the July rally. The comparison is apt. Every parent knows what usually follows the initial boost of energy following excess sugar consumption: a sudden and unplanned catnap. The stock market is looking sleepy this week.
Bonds have been a little more exciting. This week’s auctions revealed demand for Treasury securities is weakening. A $39 billion offering of five-year notes today drew a higher-than-expected yield of 2.689%. Perhaps more significant, the participation of indirect bidders – a group that includes foreign central banks – fell to 36.7%, down from 62.8% at a similar auction in June. On the other hand, the fact that Treasury has been able to raise more than $1 trillion so far this year without pushing interest rates even higher is impressive. Corporate bonds are also seeing strong demand and the U.S. dollar is finding support at its June lows against most other currencies.
Investors appear to have concluded that the worst of the recession is over. Some media outlets and analysts have even declared that the recession has ended. They may be right, but this does not mean recovery is imminent in either the economy or the markets. On an inflation-adjusted basis, corporate earnings remain far below the 2007 peak. Even under the most optimistic assumptions, we find it hard to justify anything approaching the valuations seen back then. Naptime could last longer than most people think.
Technology, which provided much of the leadership for this month’s rally, is clinging to the top spot in our rankings with Materials in hot pursuit. Tech stocks began to falter last week when Microsoft (MSFT) posted a disappointing quarter. A retreat in the leadership sector is always cause for concern, but at this point Technology is not declining, just consolidating. Investors should be alert for a break down from the short-term sideways pattern. The Materials sector has pulled back after a strong performance last week. Health Care, thanks to a big boost from Biotechnology stocks, continues to advance up the ranks and now shows the steadiest advance of all the major sectors. Telecom and Energy are still on the bottom.
The Value versus Growth stratification in our Style rankings is starting to give way to capitalization-size stratification. The top three groups are all Small Cap or Micro Cap while the bottom four are all Large Cap or Mega Cap. The momentum gap between the top and bottom categories widened from 15 to 22 RSM points.
The week brought little change in the relative Global rankings. Canada and Latin America switched places as did the E.U. and U.K., but by such slim margins that both could reverse back again quickly. China’s momentum value went into triple digits; a level we have often stated is unsustainable and indicates frothiness. As if on cue, China’s market fell 5% overnight, so we are likely to see its RSM value back in double digits by next week. Japan and the U.S. are still at the bottom of the rankings.
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.
“The July part of the rally is a bit of a sugar high.”
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