Another Week, Another Reversal
Europe’s banking sector is in near-panic mode as judicial and political obstacles make further bail-outs difficult. Banks overloaded on high-yielding sovereign debt from places like Greece and Italy now must face what is (to them) an unnatural fact: risky investments sometimes end in capital losses. Germany’s top court just today said any future bailout spending must be approved by a committee of parliament. The voters who elect that parliament are having none of it. Therein lies the crisis.
When bankers don’t know who to trust, they stop lending. When lending stops, modern economies collapse. Here in the U.S., it’s been happening in slow motion for several years. Last Friday, the Labor Department’s monthly report showed zero job growth in August – even worse than the meager projected gain of 80,000 jobs. Worse yet, average weekly hours declined from 34.3 to 34.2, which may not sound like much but is equivalent to a loss of about 300,000 jobs. Hourly earnings dropped as well.
We are not surprised, then, that President Obama will unveil a new job-oriented economic stimulus program in a speech to Congress tomorrow night. Leaks suggest he will propose both middle-class tax cuts and infrastructure spending. Both have been tried before with little discernible impact. We expect the same for whatever is proposed and ultimately enacted.
Pessimism on both sides of the Atlantic combined in a flight to quality. U.S. Treasury paper surged in value. Rates for ten-year bonds dropped well below 2%. This was perversely bullish for stocks since at current valuations the S&P 500 dividend yield outpaces T-bonds. Today’s stock rally nonetheless looks shaky to us. Selling action still dominates; volume has been higher on down days and lower on strong days.
The S&P 500 is trying to build a floor around the 1120 level. A failure to hold there will probably bring a quick drop to the next support – some 100 points lower. The dividend yield at that point would be even more attractive, of course, assuming the dividends don’t disappear. Companies may be hard-pressed to maintain payouts if the employment situation doesn’t improve. Jobs are still the key number to watch.
It’s barely perceptible, but we still have a little green in the sector rankings. The tiny upward momentum is fittingly monopolized by Utilities. The other two defensive sectors, Consumer Staples and Health Care, remain at #2 and #3 respectively, although there is a large gap between the two. Materials and Technology are in the middle of the pack. Analysts seem to be either very bullish or very bearish on these two highly volatile groups. Investors should keep in mind that at this point “middle of the pack” is very negative. Energy, Industrials, and Financials still form the bottom of the list. Ten years after the great Tech bear market, the sector has yet to show any sustained market leadership. We won’t be surprised if the Financials follow a similar path.
Large Cap Growth took the top spot away from Mega Caps, but not by much. In any case, a momentum reading of -27 is nothing to get excited about. Declines over the last few days tended to spread out the Style rankings. The weakest were hit hardest; in the four-days ended Tuesday, the Russell 2000 small-cap index lost -6.2%, compared to a -3.9% drop in the S&P 500. The Style rankings are still defined by capitalization first, then by Growth over Value. The primary exception is Large Cap Value, which slid a little further south. This group is weighed down by a large allocation in Financials.
Resource-rich regions continue showing the best relative strength. Canada moved ahead of Pacific ex-Japan (a benchmark dominated by Australia). Latin America climbed the ranks and is now a close third. Japan and the U.S. are right behind, with Japan holding a slight edge this week. Europe again posted the largest decline and further separated itself from the rest of the globe. Europe’s negative performance also impacted the EAFE group, of which it is a significant component.
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 is an open secret that numerous European banks would not survive having to revalue sovereign debt held on the banking book at market levels.”
Deutsche Bank CEO Josef Ackerman, September 5, 2011
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