Is our economy stabilizing? Are the reports on retail sales and an improving trade deficit a harbinger of better times in 2010? While I am not going to indiscriminately pooh-pooh economic reports which may be overly sanguine, I am also not going to blindly buy into them either.
Prudence dictates we neither get overly ebullient nor despondent as we manage our finances and navigate the economic landscape. In that context, I will caution readers that news deemed positive for the economy may very likely generate negative returns across a wide array of asset classes. Why is that?
The fuel that has been driving the markets all year is provided by the Fed and Treasury. That excess liquidity has served to punish the value of the greenback while supporting virtually all asset classes via the dollar carry trade. If the economy shows signs of stabilizing and the fuel source is restricted via a Fed-tightening of credit, the U.S. dollar should rise and hedge funds, speculators, and selected investors will be forced to exit positions across these asset classes.
We continued to see a semblance of this phenomena play out again this week. Will it continue? Watch the U.S. Dollar Index and expect that it will continue to be negatively correlated with the markets.
Let’s navigate. Prior to reviewing the month to date market returns, I’ll address economic data released this week.
Trade Deficit: The Wall Street Journal provides great insight on the improvements in this report:
The latest international trade report shows exports continuing an uptrend, boosting U.S. manufacturing. Imports also rose, likely reflecting inventory rebuilding for autos and cautious hope about the consumer and business investment. The overall U.S. trade deficit narrowed to $32.9 billion from a revised $35.7 billion gap in September. The deficit was smaller than the market forecast for a $36.4 billion differential. Exports advanced 2.6 percent while imports gained 0.4 percent. The improvement in the trade deficit was primarily due to a narrowing in the petroleum deficit, which came in at $17.8 billion compared to a gap of $20.5 billion the previous month. The nonpetroleum gap shrank to $25.2 billion from $25.7 billion in September.
The other important economic report released this week focused on Retail Sales. The WSJ again provides solid insights:
The consumer decided to come off the sidelines and jump back into the economy, boosting November retail sales-and beyond just autos and gasoline. Overall retail sales in November posted a 1.3 percent spike after a revised 1.1 percent gain in October. November’s increase was well above the consensus estimate for a 0.9 percent increase. Excluding autos, sales gained 1.2 percent in the latest month after no change in October. The market consensus had expected a 0.5 percent gain in ex autos. Even excluding both autos and gasoline, November sales were up a healthy 0.6 percent, following a 0.1 percent uptick the month before.
Is this strength to be believed? Early signs of holiday sales were anything but positive. Were those reports erroneous or is this report overly massaged? We’ll be watching.
Let’s move along to market performance. The figures I provide are the weekly close and the month-to-date returns on a percentage basis:
$/Yen: 89.08 versus 86.38, +3.1%
Euro/Dollar: 1.4613 versus 1.5007, -2.6%
U.S. Dollar Index: 76.57 versus 74.80, +2.4%
Commentary: the overall U.S. Dollar Index continued to firm supported by economic news (retail sales and trade deficit) that came in stronger than expected. Will the trend in positive economic news continue? Is it to be believed? Is it heavily massaged to appear stronger than reality? These questions all remain unanswered but for the time our greenback has found real support as the perception grows that Uncle Sam will be forced to withdraw support for the markets and economy sooner than previously expected.
Bernanke tempers this prospect of a Fed move in his comments. How will this play out? Uncle Sam wants to buy time whenever and wherever possible. Thus, look for more rhetoric and dialogue without decisive action in the immediate future.
Oil: $69.56/barrel versus $77.33, -10.0% !!!
Gold: $1115.6/oz. versus $1180, -5.5% !!!
DJ-UBS Commodity Index: 133.154 versus 136.49, -2.5%
Commentary: the red ink in this sector is directly correlated with the improvement in the dollar. A lot of hedge funds had sold the dollar (given the fact that it could be borrowed for next to nothing) and used the proceeds to buy commodities. As the dollar rallies, that part of these trades loses, and thus as entities cover their dollar shorts, they sell out their long positions in commodities – especially gold and oil. I have not tracked the technicals in the oil and natural gas markets closely, but am aware that supply has increased and is obviously pressuring both those markets.
DJIA: 10,471 versus 10,345, +1.2%
Nasdaq: 2190 versus 2145, +2.1%
S&P 500: 1106 versus 1096, +.9%
MSCI Emerging Mkt Index: 973 versus 941, +3.4%
DJ Global ex U.S.: 198.4 versus 197.04, +.5%
Commentary: I remain pleasantly surprised by the month to date equity market performance. Given the strength in the dollar, the move higher in longer term interest rates, and the selloff in commodities, equities have held up extremely well.
Emerging markets remain solidly higher on the month but did give ground by 1.5% on the week given concerns in select European (Greece, Ireland) and eastern European countries.
I continue to maintain, I think we are beginning to enter into a blowoff phase in which investors who have missed the market move to get in while those who are outright short the market are forced to cover. I view the current price action more akin to gambling than anything else.
2yr Treasury: .81% versus .67%, +14 basis points or .14% (rates up, prices down)
10yr Treasury: 3.55% versus 3.20%, +35 basis points or .35% (rates up, prices down)
COY (High Yield ETF): 6.67 versus 6.46, +3.2%
FMY (Mortgage ETF): 17.60 versus 17.79, -1.1%
ITE (Government ETF): 57.87 versus 58.52, -1.1%
NXR (Municipal ETF): 15.21 versus 14.80, +2.8%
Commentary: interesting cross currents at work here. Interest rates, especially for longer maturity government debt, moved higher this week as Treasury auctions were not well received. Selected European bond markets came under heavy pressure given concerns about defaults. The fact is if the Fed may be forced to withdraw stimulus and support, then rates will be forced higher as funding needs remain exorbitant. This move higher in rates can happen even without inflationary pressures.
We continue to kick the can down the road. Washington pretends to make progress on financial regulatory reform (check back later this weekend for my thoughts on that) but the American consumer and public at large remain under real duress. Are the hints of economic strength real? Whatever happened to the term green shoots?
The fact remains we live in a very fragile world, economically and politically. Our global economic risks remain deeply embedded in the debt burdens of nations, corporations, and consumers. These debts are disguised and covered by central bank liquidity. The water may appear fine, but it remains shark-filled. Remain on guard.