The Silent Fall of China
The high volatility that took hold in early August is still with us. The pattern keeps repeating: Euphoric news-driven, 2-3 day rallies that are then smashed by the subsequent decline. The heaviest volume continues to be on the downside, suggesting many investors still want to reduce equity exposure.
Departure from stocks requires a destination, of course, and good alternatives are not exactly obvious. Money market funds pay zilch. Even ten-year Treasury bonds have limited appeal: no one really wants to lock in a decade of 2% returns before taxes and inflation. They do so only because the other choices are even worse, or they do not fully grasp the investment they are making.
The Federal Reserve’s “Operation Twist” appears to be un-twisting. The goal, as we said last week, is ostensibly to flatten the yield curve by putting pressure on the long end of the scale. It worked initially as the ten-year bond rate fell as low as 1.7%. Today, however, it is above 2% and higher than before the Operation Twist announcement. That extra day of FOMC deliberations seems not to have helped very much, unless it was really directed toward some other goal.
The big-money crowd seems to be concluding that the present crisis – in Europe and elsewhere – is not simply a 2008-like liquidity crunch. Throwing cash at the problem won’t work this time. The prospect of cascading sovereign defaults, combined with weak-to-negative growth all over the globe is discouraging, to put it mildly.
Admitting one has a problem is a necessary step in finding a solution, so perhaps Europe is now on the right track. Deep disagreement remains over how to proceed – most recently about whether banks should take a larger haircut on their Greek government bonds. If the politicians do not solve the problem soon, market forces will make the decision for them.
Market action was also negative for the sector rankings. Utilities is still on top, as well as having the only positive momentum among all 32 of our equity categories. Consumer Staples fell into the red again, while hanging on to second place. Technology, which had been climbing the ranks, stayed in third position. Tech’s attempt to provide some upside leadership was not totally derailed, however; the sector did manage to turn in an “above-average” weekly performance.
At the other end of the list, the Financials managed to escape the bottom for the first time in months, though not by much. Energy, Materials, and Financials are in a near three-way tie for last place. The Industrials sector, which has typically moved hand-in-hand with Energy and Materials for much of this year, managed to put a little distance between itself and the other two this week.
Large Cap Growth still leads the Style categories but is very close to relinquishing this honor to Mega Cap. The latter group is hardly in a position to boast, however, unless one somehow finds a 20% annualized downtrend thrilling. The Mega Cap benchmark is off 5% this year and remains about 20% below its 2007 peak. Overall, the Style rankings continue to align based primarily by capitalization and then by Growth over Value. The bottom-ranked Micro Caps are in serious trouble. Multiple breakdowns have made it the worst-performing Style category not only this week, but over the last three years.
Japan moved ahead of the U.S. to take first place in the Global rankings. Not coincidentally, the Yen was the only major currency not to lose ground to the greenback after last week’s Fed action. Japan’s stock market is nevertheless in danger, as it clings to support at the March post-tsunami lows. U.S. market indexes bounced up a bit from the August bottom but as yet have not entered any new uptrends. Europe, after owning the bottom by a significant margin for many weeks, now has a companion in the basement: China. The threat of a global recession is bad news for the globe’s dominant exporter. While Europe dominates the headlines, China actually performed even worse in the last two months. Leadership of the BRIC nations seems not to provide an advantage in this market.
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.
“…every single bank we cover has underperformed the broader markets. One would have thought the market would reward those with strong balance sheets and robust capital positions, but it has not, which signals those are not the key issues this time.”
Richard Ramsden, bank analyst for Goldman Sachs, 9/28/11
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