U.S. stocks ran into some trouble yesterday, recording the worst session in two months after the World Bank lowered its global contraction estimate. This provided the impetus for some profit taking to ensue – that’s the market we’re in right now and you could feel the low volume scenario of the last month signal the market was beginning to question the rally – as we’ll touch on below.
The World Bank stated it expects the global economy to contract 2.9% for 2009, down from their previous estimate of -1.7%. That is certainly a significant contraction from a world economic perspective, but anyone who’s watched World Bank estimates knows not to give it too much credence, their forecasts are rarely even close (which is why they adjusted the previous estimate to more closely reflect reality). This downgrade should not have been a surprise, the data we’ve seen over the past several months (even though the figures have shown some improvement over the past few weeks, a rebound from very low levels but still quite weak) has offered a clear indication the worst world recession in at least 27 years is the situation. The lowered forecast simply triggered what many have been wanting to do, take something off the table, but had held pat on the possibility of additional gains.
One of the hottest sectors of the year, second only to technology shares, has been commodity-related basic material stocks and that sector was a big loser yesterday. A couple of weeks back we began talking about how this group was poised for a pull back after jumping 55% from its March low and that has certainly occurred over the few sessions. A lot of people see this market as one that is very much like that of the back-half of the 1970s and that means you’ll see short-term profit taking.
Two of the three traditional areas of safety were among the relative winners yesterday. Utility and consumer staples shares ended the session unchanged and -0.8%, respectively. The other of the big three safety sectors, health-care, failed to perform as well as would normally be the case on a day of increased economic concern – but these are not normal times; the government is coercing drug makers into offering even larger discounts. President Obama stated, “it’s only fair” for the pharmaceutical companies to make essential concessions to help reduce costs as they’ll, according to him, benefit greatly from national health-care coverage.
Big beneficiaries, eh? If we get national health care, rationing and price controls follow, that’s been the lesson from the European and Canadian systems. For now, the drug makers make concessions hoping the crocodile will eat them last, but they’ll be eaten too a few years down the road if this national health-care scheme is not blocked, make no mistake about that. The good news is it appears some in Congress are having second thoughts.
Market Activity for June 22, 2009
The World Bank stated it expects the global economy to contract 2.9% for 2009, down from their previous estimate of -1.7%. That is certainly a significant contraction from a world economic perspective, but anyone who’s watched World Bank estimates knows not to give it too much credence, their forecasts are rarely even close (which is why they adjusted the previous estimate to more closely reflect reality). This downgrade should not have been a surprise, the data we’ve seen over the past several months (even though the figures have shown some improvement over the past few weeks, a rebound from very low levels but still quite weak) has offered a clear indication the worst world recession in at least 27 years is the situation. The lowered forecast simply triggered what many have been wanting to do, take something off the table, but had held pat on the possibility of additional gains.
One of the hottest sectors of the year, second only to technology shares, has been commodity-related basic material stocks and that sector was a big loser yesterday. A couple of weeks back we began talking about how this group was poised for a pull back after jumping 55% from its March low and that has certainly occurred over the few sessions. A lot of people see this market as one that is very much like that of the back-half of the 1970s and that means you’ll see short-term profit taking.
Two of the three traditional areas of safety were among the relative winners yesterday. Utility and consumer staples shares ended the session unchanged and -0.8%, respectively. The other of the big three safety sectors, health-care, failed to perform as well as would normally be the case on a day of increased economic concern – but these are not normal times; the government is coercing drug makers into offering even larger discounts. President Obama stated, “it’s only fair” for the pharmaceutical companies to make essential concessions to help reduce costs as they’ll, according to him, benefit greatly from national health-care coverage.
Big beneficiaries, eh? If we get national health care, rationing and price controls follow, that’s been the lesson from the European and Canadian systems. For now, the drug makers make concessions hoping the crocodile will eat them last, but they’ll be eaten too a few years down the road if this national health-care scheme is not blocked, make no mistake about that. The good news is it appears some in Congress are having second thoughts.
Market Activity for June 22, 2009
Questioning the Rally
The broad market ran up nearly 40% in the two months that ended May 8 but since that time we’ve been stuck in this relatively tight range of 945-882 on the S&P 500. Which way will we go from here? Is the market spring-loaded for a significant move higher, or are the lower trading volumes of the past few weeks telling us a turn down is in the cards?
We think there has to be a move lower after such an abrupt rise from the deep depths of March, even if that low was unjustified. One thing is pretty clear, things remain fragile. If the data doesn’t begin to show meaningful improvement fairly soon investors and consumers alike may show a higher propensity to freaking out – for very understandable reasons.
If the broad market begins to turn down, investors may bolt for fear of a February/early-March style redux. This, along with an unlikely rebound in the labor market anytime soon, may also cause the consumer to increase their cash savings – nothing wrong with that as it is a prudent endeavor in this environment, but it does mean depressed retail sales activity.
So this is where we find ourselves right not and the investor needs to be aware that some pressure may ensue. When we expect a natural pullback after powerful rallies, maybe the investor class will be less prone to freaking out and driving equity values near those March lows again. It does feel that there has been the typical performance chasing going on over the past couple of weeks that has allowed the market to bounce after three spats of weakness over the past month. Those with a performance-chasing mindset need to be very careful in this environment.
A Fed Week – What will be their plan of attack?
As we mentioned yesterday, the market eagerly awaits to hear what the members of the FOMC (the monetary policy setting committee) have to say on Wednesday. We know how they’ll manage the short end of the curve – a group that is hugely dependent on the level of unemployment will hold Fed funds near zero.
The question is how they’ll manage, or attempt to manage, the long-end. Will they step up their quantitative easing strategy (increasing purchases of Treasury and mortgage-backed securities); or will they attempt to keep long rates low via comments? – comments that state the concerns over inflation are overblown.
Needless to say, with over $100 billion in debt issuance coming this week alone and $3-4 trillion over the next two years, they have a very difficult task in front of them.
Inflation Building?
And speaking of inflation expectations, they sure don’t seem terribly heightened right now. Yes, we’ve had commodity prices on a run – and some of this trade definitely has some inflation hedging in it. Yes, the jump in yields during May and early June also suggested some uneasiness, but it’s quite a stretch to say the market is seriously concerned at the moment. Heck, the 10-years TIPS breakeven can’t even hold above 200 basis points – meaning the market expects (at least currently) that inflation will run at 2% per year for the next decade. (The 10-year TIPS breakeven is the spread between the yield on the nominal 10-year Treasury note and that of the 10-year Treasury Inflation Protected Security)
But there are a number of indications that suggest prices could begin to roll in quick order if the Fed is not careful. For one, core CPI is running at an annual rate of 2.5% over the past four months – hardly scary but this an elevated level based on the economic damage we’ve endured over the past nine months. In addition, we’ve seen a building in the early stages of production regarding food prices – specifically regarding fertilizer and feed costs.
Yesterday there was a report out on how dairy farmers have had to slaughter cows due to rising feed prices. Farmers have been losing money as it has very recently cost as much as $17 to produce $10 of milk, according to the National Milk Producers Federation.
The broad market ran up nearly 40% in the two months that ended May 8 but since that time we’ve been stuck in this relatively tight range of 945-882 on the S&P 500. Which way will we go from here? Is the market spring-loaded for a significant move higher, or are the lower trading volumes of the past few weeks telling us a turn down is in the cards?
We think there has to be a move lower after such an abrupt rise from the deep depths of March, even if that low was unjustified. One thing is pretty clear, things remain fragile. If the data doesn’t begin to show meaningful improvement fairly soon investors and consumers alike may show a higher propensity to freaking out – for very understandable reasons.
If the broad market begins to turn down, investors may bolt for fear of a February/early-March style redux. This, along with an unlikely rebound in the labor market anytime soon, may also cause the consumer to increase their cash savings – nothing wrong with that as it is a prudent endeavor in this environment, but it does mean depressed retail sales activity.
So this is where we find ourselves right not and the investor needs to be aware that some pressure may ensue. When we expect a natural pullback after powerful rallies, maybe the investor class will be less prone to freaking out and driving equity values near those March lows again. It does feel that there has been the typical performance chasing going on over the past couple of weeks that has allowed the market to bounce after three spats of weakness over the past month. Those with a performance-chasing mindset need to be very careful in this environment.
A Fed Week – What will be their plan of attack?
As we mentioned yesterday, the market eagerly awaits to hear what the members of the FOMC (the monetary policy setting committee) have to say on Wednesday. We know how they’ll manage the short end of the curve – a group that is hugely dependent on the level of unemployment will hold Fed funds near zero.
The question is how they’ll manage, or attempt to manage, the long-end. Will they step up their quantitative easing strategy (increasing purchases of Treasury and mortgage-backed securities); or will they attempt to keep long rates low via comments? – comments that state the concerns over inflation are overblown.
Needless to say, with over $100 billion in debt issuance coming this week alone and $3-4 trillion over the next two years, they have a very difficult task in front of them.
Inflation Building?
And speaking of inflation expectations, they sure don’t seem terribly heightened right now. Yes, we’ve had commodity prices on a run – and some of this trade definitely has some inflation hedging in it. Yes, the jump in yields during May and early June also suggested some uneasiness, but it’s quite a stretch to say the market is seriously concerned at the moment. Heck, the 10-years TIPS breakeven can’t even hold above 200 basis points – meaning the market expects (at least currently) that inflation will run at 2% per year for the next decade. (The 10-year TIPS breakeven is the spread between the yield on the nominal 10-year Treasury note and that of the 10-year Treasury Inflation Protected Security)
But there are a number of indications that suggest prices could begin to roll in quick order if the Fed is not careful. For one, core CPI is running at an annual rate of 2.5% over the past four months – hardly scary but this an elevated level based on the economic damage we’ve endured over the past nine months. In addition, we’ve seen a building in the early stages of production regarding food prices – specifically regarding fertilizer and feed costs.
Yesterday there was a report out on how dairy farmers have had to slaughter cows due to rising feed prices. Farmers have been losing money as it has very recently cost as much as $17 to produce $10 of milk, according to the National Milk Producers Federation.
As a result, the consumer will begin to take the brunt of these higher costs as the slaughtering of dairy cows will lead to the first two-year production cut in four decades, according to data from the Department of Agriculture.
This is just another example of the ingredients being there for inflation rates to cause havoc over the next 12,18, 24 months. The timeline is the debate, I happen to believe the inflation gauges will begin to run up 12 months out, many other believe it will take more time to build. But it does seem pretty evident that we’ll have an issue on our hands whatever the time horizon happens to be. All that’s needed now is for increased credit activity and a little economic growth to stir the inflationary brew.
This morning we get existing home sales for May. If the previous pending home sales data is any indication, and it usually is, we’ll see May home sales beat expectations. Stocks may be able to bounce off of yesterday’s move if this data surpassed the estimate, but we’ve got the text from the FOMC meeting tomorrow so traders may just hold off for that release.
Have a great day!
Brent Vondera
1 comment:
Excellent summary! I will make a presentation based on my book, TIMING THE MARKET (Wiley, 2005), to one of your colleagues tomorrow - David Ott. I look forward to meeting him and wish you could join him!
All my best,
Deborah Weir, CFA
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