As January goes, so goes the year.
Does this adage hold water? The market direction for the year is correlated approximately 70% of the time with January’s move. I certainly would not make investment decisions based purely upon that rule of thumb. The rule did not hold in 2009 as major equity averages were down 8% last January. That said, 2009 was anything but a normal year given the massive economic and market supports implemented by Uncle Sam.
What rule of thumb would I recommend? Read and review Sense on Cents regularly to most effectively navigate the economic landscape. On that note, let’s review the market moves for January. The figures provided are month end statistics for the respective markets, then month-to-date and year-to-date returns.
The U.S. dollar had a very solid month with the overall index gaining 2.1% on the month. The dollar did weaken versus the Japanese Yen while strengthening versus the Euro. Please be aware the Euro/dollar quote above looks at the currency swap from the perspective of the Euro. Why? Most market participants quote it in that format so it becomes the standard. Red ink there means our greenback strengthened versus the Euro.
Are we witnessing the unwind of dollar carry trades (that is, sell dollars because they can be borrowed so cheaply given the 0-.25% Fed Funds rate and use the proceeds to buy risk-based assets, including commodities, equities, and bonds) that were so prevalent in 2009? I believe we are. Why might these trades be unwound? The expectation that global governments and central banks, including our own, are withdrawing supports for their economies and markets. Why? Fears of asset bubbles and incipient inflation. This dynamic is playing out most prominently now in China where banks are curtailing lending. What impact has this had? Let’s move on to our review of . . .
This sea of red ink is not indicative of expectations of strong future economic growth. The losses here are widely due to the unwind of trades as highlighted above. Within the commodity space, copper specifically got hammered and was down 10% on the month. That base metal is used in both residential and industrial production. Given this move in commodities, no surprise that equities in general and especially within the emerging economies were down on the month. Moving right along . . .
The equity markets were up approximately 2% the first week of the year, but then came off hard. In my opinion, the selloff was a function of the points highlighted previously (withdrawal of government and central bank supports) but also the realization of the following:
1. Global economy remains challenged. Greece is on the edge of a sovereign default.
2. Our domestic economy, especially within the labor and housing sectors, continues to face an uphill climb. State and municipal finances are a mess.
3. Washington is also a political and fiscal mess. You already knew this.
4. Obama’s slamming Wall Street and promoting the Volcker Rule to remodel banks is not exactly leaving Wall Street with a warm and fuzzy feeling.
5. The prices of stocks look quite full relative to earnings generated and earnings projected.
So where are investors putting cash? Moving right along . . .
Interest rates on government debt came down (remember rates down, bond prices up) and other sectors of the bond market held up quite well as investors look for a bit of a safe haven while trying to generate some sort of yield. In my opinion, the bond market looks overpriced given the ongoing risk of defaults (corporate and consumer) but also given the massive deficits at the federal, municipal, and consumer levels. Each of these sectors of our economy have enormous funding needs. As Uncle Sam lessens his ability to provide that funding, I believe interest rates have to move higher.
Risks remain abundant. Navigate accordingly.