Bernanke Downgrades U.S. to Permanent ZIRP
Where to begin? We will start by saying the S&P downgrade of U.S. long-term Treasury debt was largely irrelevant, and certainly not responsible for the stock market’s losses. Bond traders obviously agree; the downgrade seems to have made Treasury paper more valuable than ever. The ten-year yield fell as low as 2.1% this week.
The bigger culprit is across the sea in Europe, where the banking sector is widely thought to be on the edge of collapse. The European Central Bank reportedly bought large amounts of Spanish and Italian government bonds today. At the same time, a slide in French banking shares suggests the region’s second-largest economy may be in trouble as well. The London riots, while not directly related to the economy, certainly don’t make Europe look any more stable.
It was in this environment that the Federal Open Market Committee convened yesterday for a regular policy meeting. The result was anything but regular. Central bankers rarely make guarantees about anything, but the Fed got about as close as it can by saying it plans to keep short-term interest rates at “exceptionally low levels” (i.e., at or near zero, also known as Zero Interest Rate Policy, or ZIRP) until at least mid-2013. Their stated reason was “to promote the ongoing economic recovery”, but a similar strategy hasn’t worked out so well for Japan.
Investors clearly do not believe economic recovery is “ongoing” or even in sight. The unremarkable 2Q earnings season suggests the era of cost-driven profit margin growth is drawing to a close. In the two-week period ended Monday, the S&P 500 dropped -16.3%, the Russell 2000 fell -21.7%, and the Nasdaq Composite shed -17.1%. This qualifies, at the very least, as a “mini-crash.” As with most crashes, there were moments of extreme bullishness; the Fed announcement sparked one of the best one-hour periods in stock market history. The rally came undone today.
Gold continued to fill its traditional role of refuge in crazy times, at least for those unwilling to buy Treasury bonds. Bullion prices hit new all-time highs above $1,800 per ounce. Gold will pull back at some point, perhaps sharply so, but seems set to move higher first.
Last time we characterized the Sector relative strength as “noticeably less bullish.” We have now downgraded our rating to “nothing bullish at all.” The top-ranked sector is now Consumer Staples, which is moving downward at a -27% annualized rate, and the picture gets worse from there. Energy had one of the fastest drops in recent memory, falling from first place last week with an RSM score of +1 to a seventh-place rank and an RSM of -71 now. Technology and Health Care improved their relative positions but still look miserable. Financials and Industrials remained at the bottom of the heap as the pile grew heavier. The negative momentum is growing extreme in some cases, which means we could see some corrective bullish action soon. Where such action will be, and how long it can be sustained, is unpredictable.
The Style categories are now lined up by size, with Mega Cap on top and Small Growth on the bottom. The exception to the rule is Micro Cap, which is currently wedged between the Large Cap and Mid Cap groups. The widespread losses create sort of an optical illusion on our ranking graphic. At first glance everything looks about equally dismal, but in fact the momentum values fall off sharply as we go down the list. Mega Cap is in bad shape with an RSM of -46, but Small Growth is truly terrible with its score of -84. After more than two years dominating the charts, Small Growth’s reign may have come to an end.
The best we can say about Japan’s continuing leadership is that it’s the only global category with an RSM level better than -50. As we mentioned last week, Japanese stocks failed an upside breakout attempt, and now the April support level has been breached. The next stop will be March’s post-tsunami panic low. The next eight categories are all bunched together with momentum readings in the -60s. The U.S. is part of that pack at -62. Latin America and Europe are on the bottom, showing that developed and emerging markets are not always as “decoupled” as some people think. Nevertheless, Europe remains the epicenter of global financial chaos and seems likely to hold that distinction for another week.
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.
“Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expectedjob.”
FOMC Statement, August 2011
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