We are reaching a point in our new “Uncle Sam” economy where rhetoric from Wall Street, Washington, and global financial centers seems to be having greater impact than true market and economic fundamentals. Why? Our financial and political ‘wizards’ are working overtime to reconnect the great ‘disconnect’ between Wall Street and Main Street. While we receive glimmers of hope in certain economic statistics, the dark clouds in employment and housing remain daunting.
Are the ‘Washington wizards’ (Bernanke, Geithner, Summers) providing hints of support for our greenback while truly hoping for a manageable decline? I believe they are, and I believe this financial engineering is a very dangerous game.
- Non-manufacturing Institute of Supply Management: this report rose above 50 (an indication of growth) with a positive development in new orders (this is clearly good), but with no signs of improvement in employment and pricing power by manufacturers.
- Redbook: indications of slight improvement in same store sales although next week’s Retail Sales report will likely look exceptionally weak as it incorporates an end to the ‘Cash for Clunkers’ program. Overall signs point to what is expected to be a weak holiday retail season.
- Jobless Claims: overall claims declined, which presents a sign of stability within employment. That said, it is hard to be optimistic on the employment front on the heels of the employment report released on October 2nd (embedded within the Equity section of this commentary).
- Trade Deficit: this deficit surprisingly narrowed, with a slight increase in exports combined with a slight decrease in imports. All other things being equal, this report would be positive for our dollar but the noise surrounding our currency is overwhelming the focus within this one month reading.
I would typically lead my review with focus on the equity and bond markets, but those sectors are actually following developments in the currency and commodity markets so let’s shift our focus accordingly.
How did the markets handle the Fed-speak, the data, and technical flows? Let’s continue navigating. The figures I provide are the weekly close and the month-to-date returns on a percentage basis.
$/Yen: 89.78 vs. 89.68
Euro/Dollar: 1.4709 vs. 1.4635
U.S. Dollar Index: 76.35 vs. 76.72
Commentary: the overall U.S. Dollar Index has declined by approximately .5% this month, but the volatility and focus on movements in this space have been tremendous. Precipitated by an increase in rates by the Australian Central Bank midweek, the U.S. Dollar Index plunged below 76 which represents multi-year lows. The dollar weakness led to a move higher in global equities as traders, investors, and speculators were emboldened to enter into more ‘positive dollar carry trades.’
While I think Washington is not disappointed in a relatively weak dollar, although they should be (”Dollar Devaluation Is a Dangerous Game”), other countries are not overly keen about further dollar weakness. Why? A weak dollar puts those countries in a marginally less competitive position in international trade. ECB President Jean-Claude Trichet voiced his concerns on this topic. Rest assured, the Asian nations feel the same way although they are careful in their comments. Adding further fuel to dollar weakness was speculation that the trading of oil and a basket of other commodities, which are currently transacted in U.S. dollars, would shift trading away from being dollar-based. On that note, let’s review the action in commodities.
Oil: $72.29/barrel vs. $70.39
Gold: $1050.1/oz. vs. $1008.2 !!!! THE BIG WINNER !!!!
DJ-UBS Commodity Index: 129.177 vs. 127.683
Commentary: I view this segment of the market to be the STRONGEST indicator of the global economic pulse. Additionally, the price action in commodities is likely a strong indication of the ‘positive carry’ trade put on by hedge funds and other traders.
The overall commodity index has moved higher by approximately 1.2% on the month, but the movements within specific commodities is gaining the real focus. Gold specifically has soared by over 4% this month. Why? Market speculation about a potential further slide in the greenback would be inflationary. Oil and other commodities also benefited from the story I referenced above. The conundrum I find in this space revolves around overall levels of international trade. Are these commodities moving higher truly because of an increase in demand or merely because of speculative investing and trading? Where do we go to get a pulse on that? The Baltic Dry Index. How is our friendly indicator of global shipping activity doing?
The Baltic Dry Index continues to move marginally lower. Can global equities in general and commodities specifically increase in value if the major indicator of global trade, that being the BDI (Baltic Dry Index), is in a downtrend? I think not for the long haul, but for a period of time a cheap funding vehicle, that is the U.S. dollar, can override market fundamentals.
I read these commodity tea leaves as sign of inflationary expectations in these ‘inputs’ while we encounter deflationary pressures in wages and real estate. What a world.
DJIA: 9865, +1.6%
Nasdaq: 2139, +0.8%
S&P 500: 1071, +1.3%
MSCI Emerging Mkt Index: 946, +3.6%
DJ Global ex U.S.: 197.6, +1.5%
Commentary: equities regained momentum after last week’s selloff. Recall how just one week ago, we faced a remarkably weak and disappointing Unemployment Report which culminated a week in which equities had given up approximately 2%. Well, we not only recaptured that decline but rallied further by another 1-2%. This past week accounted for the strongest advancement in equities since early July. Are we poised for a breakout past 10,000 on the Dow? Well, we need to remain focused on what is driving the market . . . and that is the weak greenback.
Indications of economic strength in Australia compelled the Australian Central Bank to raise rates which drove the Aussie higher and the dollar to new lows. In the process, the ‘dollar carry trade’ gained momentum propelling global equities higher.
The initial earnings reports released continue to show no real signs of improvement in top line revenue generated by increased sales while the bottom lines have improved given ongoing cost cutting progams. If a company cuts ALL its costs, will its stock still go higher? Rising stock values ultimately need to be driven by ‘growth.’
2yr Treasury: .97%, an increase of 2 basis points or .01%
10yr Treasury: 3.39%, an increase of 9 basis points
The yield curve steepened (longer maturities underperformed shorter maturities) under the weight of another Treasury refunding (3yr, 10yr, and 30yr). The 30yr auction on Thursday was disappointing which precipitated the selloff. The bond market has been trading in sync with equities for the last few months. That price action is an anomaly as typically bonds will trade in an inverse relationship with equities. Comments by Bernanke in the latter part of the week about an eventual and timely increase in rates by the Fed did take the wind out of the bond market’s sails.
COY (High Yield ETF): 6.64, +3.8%
FMY (Mortgage ETF): 17.85, +0.3%
ITE (Government ETF): 57.77, -0.3%
NXR (Municipal ETF): 14.46, +0.1%
Commentary: while interest rates did move marginally higher over the week, overall they remain at remarkably low levels. The high-yield market remains on fire as that sector is benefiting from a lot of hedge funds allocating capital via the ‘dollar carry trade’ referenced previously.
The game continues. The disconnect between the overall domestic economy and the price action in the markets presents what one noted investor described as ‘the greatest experiment’ in modern finance. To the extent that people are putting money to work, I would focus on buying quality and utilizing ‘dollar cost averaging’ techniques.