On the dollar, there are actually two ways to view the direction of the greenback right now. One take is the safety trade has waned and that means a move from the safe-haven of the Treasury market and into riskier assets, which would be a positive signal. The competing view is that currency traders see monetary policy as unsound for longer-term price stability and the current fiscal policy as reckless. Since the Treasury market rallied yesterday its kind if difficult to go with the former, at least in terms of yesterday’s activity.
On the positive side of things, the latest pending home sales data was very upbeat, and comes on the heels of two-straight gains (February and March) – this suggests existing homes sales will bounce from the very low levels of the past few months. More on this below.
Commodity-related basic material shares led yesterday’s advance with consumer staple and health-care shares not far behind – a little sector rotation out of financials and tech and into those traditional sectors of safety as traders may be hedging bets regarding the near-term direction of the market.
Market Activity for June 2, 2009
Commodity Prices
Commodity-related shares have led this three-month rally; the S&P 500 index that tracks basic material stocks has jumped 55% since early March and commodity prices in general have bounced 30% from their seven-year low as measured by the CRB. While we believe this sector will remain an area investors should have exposure to over the next 12-18 months, the whole commodity theme has become very consensus and that does cause very short–term concerns. We may see these stocks, and commodity prices specifically, pull-back -- whatever the trigger for that move may be; the likelihood of a pullback before marching higher again seems pretty elevated in my opinion. The continually shrinking dollar (as measured against other currencies) coupled with large and specifically targeted stimulus spending out of China should be enough to lead this group higher, but probably not without some retracement first.
Credit Spreads
A recurring theme I view as appropriate is to remain carful and cautious in this economic and geopolitical environment. It is really nice to see the equity markets advance like this but it can also cause people to put down their guard and when emotions get going investors are sometimes compelled to increase their exposure to riskier assets. But in light of what I’ve been calling reckless fiscal and monetary policy, along with geopolitical risks that certainly seem heightened, there may be additional troubles to deal with – rough spots that may reemerge over the next year or two as the market reacts to massive levels of government spending, the largest budget deficits as a percentage of GDP since WWII and the ramifications of very easy monetary policy and the eventual unwinding of this very aggressive stance that Bernanke and Co currently have in place.
With regard to monetary policy one has to be particularly leery with respect to the tendency for the market to send the wrong signals; or more appropriately put, it can result in activity that may be misconstrued by market participants. Make no mistake, whether it be the fiscal or monetary stance these actions have costs. They may ease the downside, as certainly monetary policy action has, in the short term, but there will be consequences down the road – the question is, how far down this road do the consequences lurk?
This brings us to credit spreads – the narrowing of these spreads to be exact -- which is one of the main positives that has clearly fueled this stock market rally from the deep depths of the March 9 low. That is, the spread between corporate yields and Treasurys has compressed, which is normally a sign risk appetites have increased and a major reason investors are seeing the all clear signal. When investors are more willing to take risk, this generally means the risk of default and economic trouble has subsided.
AA Corporate Spreads
But has it? Is there a chance the rush into corporate bonds is more a function of the Fed’s action than anything else? Since the Fed has pushed cash and equivalent yields, and until very recently yields across the entire curve, lower than would otherwise be the case, this may be engendering another situation in which investors are not appropriately assessing risk as they hunt for yield. If there’s nothing to this idea, then the narrowing in corporate spreads over Treasurys is a good thing – even if spreads do remain wide from a historical perspective. If there is something to this idea, however, then there could be another level of nasty to deal with in the not-too-distant future and that alone is reason to keep up your guard and refrain from getting aggressive here.
Pending Home Sales
Pending home sales rose for a third-straight month in April, according to the National Association of Realtors. Pending sales of existing home jumped 6.7% for April, blowing by the expectation of just a 0.5% increase. (We’re on quite a nice little streak of the data beating expectations here; Monday it was better-than-expected manufacturing and construction spending reports and now this one) The increase was fueled by a 32.6% surge in pending sales in the Northeast and a 9.8% rise in the Midwest. Pending sales were up 1.8% in the West region; the South declined 0.2%.
The April rise follows a nice 3.2% advance for March, and portends existing home sales will bounce from the very low levels in which they presently reside – most of these pending orders will result in existing home sales over the following two months as those sales are not counted until contracts close. Assuming these desired purchases do not run into trouble along the process (the loss of a job or the financing falls apart) May and June existing sales will look good.
This morning all eyes will be on the preliminary employment reports (the Challenger Job Cuts Announcement survey and the ADP Employment report) that precede the official monthly jobs report, which will be released on Friday. We also have Fed Chairman Bernanke on Capitol Hill, which always received attention. In addition, the ISM service-sector survey for May will be released at 9CT and it will need to advance toward the 50 mark (the line of demarcation between expansion and contraction) in order to expand upon the relatively good reports of the past two days.
Have a great day!
Brent Vondera
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