Monday, May 10, 2010

Weekly Market Update May 9, 2010

Last week brought back, at least temporarily, our worst memories of September 2008.

For the week, the Dow Jones Industrial Average (DJIA) lost 628 points (5.7%) closing at 10,380. The S&P 500 fell nearly 76 points (6.4%) closing just below 1111. This puts both of these major US indexes into negative territory for the year with the DJIA off 0.5% and the S&P off 0.4%. These drops came in the face of generally good economic news here in the US. Last Friday, the Dept. of Labor announced that 290,000 new jobs were created in April, the best number in four years. Private sector jobs provided the bulk of the new jobs which is a very good trend. The overall jobless rate increased, however, from 9.7% to 9.9%; but in general, the news of job growth is positive and I look to see whether or not these numbers will continue to improve. I believe that government jobs (excluding temporary census workers) will be a drag on the employment numbers as more and more state governments lay off workers in response to their own budget shortfalls.

The MSCI (EAFE) World suffered a 10% set back last week and for the year this broad international index is now down 12% for the year.

The Euro fell to a 14-month low against the dollar closing at $1.2760 compared to $1.3295 from a week earlier and down from its 2009 close of $1.4316.

Oil has shed nearly $11 per barrel in the past several weeks closing around $75 per barrel. It may be counter-intuitive that oil prices should tumble in the face of one of the worst oil spills in history (reduction in near and long-term supply); however, much of the oil price changes have much to do with the strong US dollar. Ninety percent or more of all oil contracts are traded in US dollars. As the dollar gains strength against other currencies, the price of oil rises for most of the world. Higher prices equal lower demand. Also, traders perceive the problems in Europe could result in economic slowdowns and lowering overall demand for oil-hence the lower price of oil right now.

Gold rose to $1210 per ounce as the metal resumed its role as a traditional "safe haven." I would be wary of gold at this price especially if the markets accept the recent moves taken by the EU to help Greece.

Demand of US treasuries surged on worries from Europe driving the yield on 10-year notes down to a 3.4199% close on Friday from its previous Friday's close of 3.6590%. Corporate bonds also performed well during the week but did give back just a little on Friday.

Dow Plummets in Minutes

As bad as the final tallies in the markets were for the week, most people were shaken by the sudden fall of the DJIA and other indexes just after 2:40 PM on Thursday.

During a 15-minute period, the DJIA lost nearly 1000 points falling to 9869 only to see the markets turn right back and gain back most of those losses closing the day at 10,520 (-348 points, -3.2%). This unprecedented volatility left many traders and investors wondering what in the heck just happened. Stories quickly circulated that a trader made a simple order-entry error when selling Proctor & Gamble stock by placing an order valued at billions, not millions of dollars which in turn caused the computers to suddenly start selling in response to the drop in the DJIA (Proctor & Gamble is one of the thirty stocks making up DJIA). At this point in time, the SEC has been unable to determine the validity of that story; however, it is certain that computers, not humans, were the driving force behind the sudden sell-off and recovery.

You may not realize that less than 30% of all trading volume in New York Stock Exchange (NYSE) listed stocks actually takes place on the NYSE. Most stock trading today takes place on a wide network of interconnected computer systems. Using this system has allowed the cost of trading to drop dramatically and the volume to increase to billions of shares each day. It is a far cry from the days when groups of men gathered outside a tavern on Wall Street to negotiate between themselves to buy and sell stocks and bonds. It appears this new computerized system went on autopilot sending sell orders flooding into the system without human intervention.

The SEC and the rest of Washington is launching investigations to get to the bottom of this very important story and I feel certain that the cause will be found and measures put in place to prevent this sort of mêlée from happening again.

Greece, Again and Again and Again

As those of you who have been reading my weekly updates since I started writing them earlier this year know that I have been discussing the financial problems facing Greece since my very first update.

It appears that this situation reached a true crisis level causing much of the selling in markets around the world.

One of the points I have been making about Greece is that a bailout would not work if there were not strong, effective spending cuts put in place by Greece to get their spending more in line with their ability to pay for their that spending. Even as the Greek parliament was passing the initial set of austerity measures, the images of rioters in the streets protesting these cuts was being broadcast nearly around the clock calling into question the ability of Greece to actually impose the kind of fiscal discipline required to get their spending under control. With Portugal, Spain and Italy looming in the shadows, investors felt that the €110 billion bailout package passed by the European Union (EU) the previous week was simply not enough to deal with the "contagion."

Over the weekend, the financial leaders of the EU came together determined to address the perceptions that the amount of the bailout was not enough and that their governments were behind in handling this crisis. The result was an announcement late Sunday, May 9th, that the EU had taken steps to put together a €750 billion ($952 billion) bailout package designed to prevent a collapse of the Euro and the European economies. The US Fed has a major roll in this package because it has agreed to open a window allowing the European Central Bank (ECB) to borrow dollars (giving Euros in exchange) to help European banks meet their dollar demands. The US will also be contributing towards the bailout via the International Monetary Fund which increased its share of the bailout significantly.

The size of the bailout (remember two weeks ago we were discussing a €40 billion bailout) will certainly help address the current crisis. As I am writing this the Asian markets closed up strongly on Monday and the European markets are up dramatically over the early hours of trading. This move may just stem the crisis for now, however, I still find myself asking the exact same question, "will European spendthrift governments reign in their spending and get their budgets in line?" Based upon what we have witnessed in the past couple of weeks, the financial markets will answer these questions for us on their own time schedule. At the very least, the size of the announced bailout will hopefully give European nations time to get their act together.

Looking Ahead

When I mentioned that volatility was likely to be returning to the markets I had no idea just how much. Last week was the most volatile we have seen in over a year. It appears that Monday will get off to another volatile trading session, only this time in the positive direction. There is no certainty that this positive move in the markets will hold and prove that last week was a short, but swift, market correction: or whether or not the markets continue to lose ground.

The Dorsey Wright (DWA) indicators that I follow dropped International Equities out of the favored top two categories of their five major categories (US Equities, International Equities, Fixed Income, Commodities, and Currencies) and replaced it with cash. I am not surprised this happened because the international markets had been fading recently. I was surprised at how quickly the category was pulled out after coming back into favored status just a month or so after being removed in February. This type of volatility in the favored major DWA categories is not typical. Relative strength analysis will struggle and test our patience in tight, range bound markets and turning points. We are currently experiencing the first, and possibly both of those scenarios right now.

Within the US equities space the strongest sectors remain US REITs, Consumer Discretionary, Information Technology, Materials and Financials. The remaining six sectors in order are Industrials, Consumer Staples, Energy, Telecommunications, Health Care, and Utilities.

Small and Mid Cap also remain favored. Growth is preferred over value.

International is to be under-weighted or eliminated, but if you do have international in your portfolios, the focus continues to be on the non-developed countries. I would specifically avoid European stocks.

Corporate Intermediate-Term and International bonds remain favored.

As an investor, you must weigh your risk tolerance and comfort level during these market gyrations. If you are not comfortable, go to the sidelines. The markets ebb and flow. If you missed today's rally because of a desire to preserve principal, there will be other opportunities in the future. Investing is not a day event, but rather a collection of actions over a much longer time horizon.

As always, if you have any specific questions on your portfolio or wish to talk to me, please do not hesitate to call.

P.S. If you think this type of analysis would be of benefit to anyone you know, please share this communication with them.

Sincerely,

Paul Merritt, MBA, CRPC(R) Principal NTrust Wealth Management