Divided Government In Action
The stock market made a strong start in December, with the S&P 500 gaining 4.0% so far this month. More critically, the index peak in November around 1225 now seems to be serving as short-term support. This suggests further gains in the next few weeks. As usual, the gains can be attributed to multiple factors that are hard to sort out. Some positive economic data, a tax deal in Washington, generally good holiday feelings, and year-end window-dressing are all at work.
The apparent agreement between the White House and Congressional leaders to extend the Bush-era tax cuts is a big deal, for more reasons than meet the eye. We noted back in November that divided government can be helpful in forcing leaders to compromise. It is already happening. The Republicans are getting the tax cuts they wanted and the Democrats opposed, while the Democrats are getting the economic stimulus they wanted and the Republicans opposed. Attempts to portray it as a victory for one side or the other miss the bigger point, which is that things are now actually getting done in Washington. Whether they are the right things is another subject, of course. For the moment, markets are giving the deal a thumbs-up.
Fed chairman Ben Bernanke appeared on 60 Minutes over the weekend. As always, his words were guarded, but he still left some interesting impressions. We thoughthe seemed remarkably unconcerned about potential inflationary effects from the Fed’s quantitative easing. News stories made hay out of Bernanke’s refusal to rule out a QE3 if QE2 proves not to be enough. This did not surprise us; Fed leaders rarely make categorical statements. They always leave themselves at least one escape hatch.
Treasury bonds plunged on Monday, the day after the Bernanke interview aired, indicating that the chairman’s words were not well received. The selling intensified today as the rate on ten-year notes hit 3.33%. It was below 2.5% as recently as a month ago. Long-term Treasury bonds are probably oversold at this point and should correct soon, but the trends are definitely not bullish for bondholders. Gold bullion briefly rose to a new high above $1400 earlier this week before pulling back. Crude oil is trading above $88, and commodities were strong across the board.
Materials and Energy are running neck-and-neck for the top spot in our sector rankings. Last week, Energy had a slight edge; now Materials is ahead by a nose. Not coincidentally, these are the two sectors most correlated to commodity prices at a time when commodity prices are strong. Cotton, silver, and copper have recently manged to post some huge gains. Consumer Discretionary is still in third place as early indications show retailers are having a profitable holiday season. A big bounce this week finally lifted Financials out of last place, but we remain skeptical of the sector’s ability to put together a sustainable rally. For the moment, though, the Financials are out of the basement and the classic defensive trio (Utilities, Health Care, and Consumer Staples) are now at the bottom of the list.
Small Cap Growth heads the Style rankings and is also doing better than the top Sector and Global categories. We’ve mentioned in the past that having one of the Style categories at either extreme (top or bottom) is a rare event; typically, the less diversified Sectors and Global regions claim that title. We are watching with interest to see how long this condition will persist. Small Cap Blend moved into second place, pushing aside Mid Cap Growth and Micro Caps. Large Cap Value, long at the bottom of our rankings, managed to move up a step and leave the Mega Caps in last place.
Canada tightened its grip on first place in the Global rankings. This is not surprising since Materials and Energy, two of Canada’s largest industries, are the top-rated sectors right now. The U.S. and Japan held on to the #2 and #3 spots as the Developed Markets (except for most of Europe) experience a revival of sorts. Speaking of Europe, the E.U. region is still in last place but did manage to move into positive momentum territory this week. We see this as mainly a bounce from oversold conditions; sovereign debt problems are still a negative influence in Europe. China is virtually tied with Europe for last place. Possibly the Chinese government’s efforts to cool down the economy are starting to bear some fruit.
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.
“Profits take care of themselves, but losses never do. The speculator has to insure himself against considerable losses by taking the first small loss. “
Jesse Livermore (1877-1940)
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