Five of the eleven major economic sectors outperformed the DJIA. Information Technology led with just over a 1% gain last week followed by Real Estate, Financials, Consumer Staples, and Industrials. Health Care was the weakest sector losing just under 1% followed by Utilities, Consumer Discretionary, and Materials. The bottom four sectors all posted slightly negative returns for the week. For the year, Real Estate remains the best performing sector posting a nearly 16% gain followed by Information Technology, Financials, and Consumer Technology. All but Energy, Utilities, and Materials have outperformed the DJIA so far in 2012, and all sectors are positive through the 31st week of trading.
The European-heavy MSCI (EAFE) index fell sharply on Thursday following Mr. Draghi’s remarks, but rallied alongside US indexes on Friday to finish 1.5% higher for the week. To summarize what has happened with Mr. Draghi over the past week I would simply say he over-promised and under-delivered. After pronouncing that the ECB would do whatever it takes on July 26th, investors implied (rightly or wrongly) this to mean he would immediately begin buying the bonds of Spain, Italy, and the other struggling European countries. Investors were expecting Mr. Draghi to announce details about how he was going to save the Euro at his press conference last Thursday. When he failed to deliver, European markets sold off sharply and interest rates on sovereign bonds jumped in the weaker countries. I believe that Germany’s continued resistance to more aggressive ECB monetary policy prevented Mr. Draghi from announcing new bond purchases and curtailed his plans. Even so, the European Union may have been given an August reprieve to continue their efforts to enact serious fiscal and political reform.
The employment data coupled with the US Federal Reserve Chairman’s recent remarks indicating the Fed will not take any immediate steps to further stimulate monetary policy in the US pushed the US dollar down for the week. The US Dollar Index fell 0.4% last week and is now down three of the past four weeks. The Euro managed a very modest 0.5% gain last week to close Friday at $1.238 rallying on the US employment report.
Bond markets were flat following the equity markets’ rally Friday with the Barclays US Aggregate Bond index up just 0.1% for the week. The Spanish 10-year yield jumped to 7.17% on Thursday following Mr. Draghi’s comments but rallied on Friday to close at 6.85%. Friday’s risk-on trade in turn pushed down US bonds with the 10-year and 30-year Treasuries dropping for the week as interest rates rose to 1.57% and 2.65% respectively. I understand this may be a bit hard to follow so I will try to simplify. US bonds are a “safe haven” place for investors to place their money when they are nervous. Buying US bonds pushes up the price of bonds (more demand equals higher prices) and thus drives down the interest rate. Spanish and Italian bonds are very risky assets today. When investors are nervous about their money, they sell riskier assets (including Spanish and Italian bonds) to invest their money in “safer” investments. This has the effect of driving prices down on risky assets and interest rates higher on Spanish and Italian bonds. Friday, when investors were feeling more secure, they returned to buying riskier assets and the prices of Spanish and Italian bonds rose causing their interest rates to fall.
HAVE WE BECOME FRANCE?
On a recent Saturday evening, Virginia and I were returning home from Stafford, Virginia, after spending a wonderful day celebrating our granddaughter’s 7th birthday. I was listening to Larry Kudlow on the radio and one of his guest speakers was one of my favorite economists, Brian Wesbury of First Trust Advisors. Brian made a statement I thought I would never hear in my lifetime. He said that the United States had become France! Ouch. He went on to say we had become France because we now have unemployment routinely greater than 8%, persistent economic growth of 2% or less, runaway government spending, and a shrinking defense budget.
Last Friday, the US grew private sector employment by a relatively paltry 172,000 while overall employment improved by 163,000 (the government sector shrank by 9000). Yet the DJIA rallied 217 points (1.7%). Why? Because we are now France. Investors were expecting an even more anemic jobs report, but were happily surprised by the larger number. Yet, the unemployment rate actually added an additional 0.1% to 8.3% overall. Forty plus months of 8% or greater unemployment—sounds a lot like France.
I do not expect anything significant to change in the near-term. With the President and Congress at a stalemate, there is zero expectation for any meaningful reform that will propel our economy forward to higher growth until after the election. Europe is also in a wait and see mode, although they are waiting to see how the power struggle between the ECB and the German Central Bank will play out. Will the spendthrift nations get more money to spend or will the tightfisted Germans force meaningful political, fiscal, and labor reforms on their neighbors? We will all be watching as these key debates unfold.
Have we become like France as Brian Wesbury suggests? Yes if you look at current economic data, but I believe most Americans do not have a European mindset. It was not that long ago that our ancestors got on boats for a dangerous trip here because they did not think like their fellow citizens. So no, I do not think we are like France today, but we have drifted very close to the French economically.
August is here. Vacation time is here. I suspect most people will not be as focused on the markets as they might otherwise be during the rest of the year. There are relatively few economic reports in the coming week, and earnings season is pretty much over. Trading volumes are likely to be down and any significant market moves may come from the few rather than the many.
The Dorsey Wright & Associates (DWA) current technical analysis shows US stocks and Bonds as the two strongest major asset classes followed by Currencies, International stocks, and Commodities. Within the US stock asset class, Middle capitalization stocks are favored, growth is favored over value, and equal-weighted indexes are favored over capitalization-weighted indexes. On a relative strength basis, Real Estate, Consumer Discretionary, Health Care, and Information Technology are the four strongest sectors on a relative strength basis. Energy, Telecom, and Materials remain the weakest. Within the Bond major asset category, US Treasuries and International bonds are favored.
The New York Stock Exchange Bullish Percent (NYSEBP) closed at 53.77 up from 53.32 (0.8%) from the previous week. Not a definitive move, but a positive one none-the-less. Bonds in general and municipal bonds specifically remain very overbought indicating that prices have gotten very expensive in relation to prices over the past ten weeks. I would not initiate new positions here.
Paul L. Merritt, MBA, AIF®, CRPC®
NTrust Wealth Management
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Emerging market investments involve higher risks than investments from developed countries and involve increased risks due to differences in accounting methods, foreign taxation, political instability, and currency fluctuation. The main risks of international investing are currency fluctuations, differences in accounting methods, foreign taxation, economic, political or financial instability, and lack of timely or reliable information or unfavorable political or legal developments.
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TIPS are U.S. government securities designed to protect investors and the future value of their fixed-income investments from the adverse effects of inflation. Using the Consumer Price Index (CPI) as a guide, the value of the bond's principal is adjusted upward to keep pace with inflation. Increase in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable.
The NYCE US Dollar Index is a measure that calculates the value of the US dollar through a basket of six currencies, the Euro, the Japanese Yen, the British Pound, the Canadian Dollar, the Swedish Krona, and the Swiss franc. The Euro is the predominant currency making up about 57% of the basket.
Currencies and futures generally are volatile and are not suitable for all investors. Investment in foreign exchange related products is subject to many factors that contribute to or increase volatility, such as national debt levels and trade deficits, changes in domestic and foreign interest rates, and investors’ expectations concerning interest rates, currency exchange rates and global or regional political, economic or financial events and situations.
Corporate bonds contain elements of both interest rate risk and credit risk. Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest, and if held to maturity, offer a fixed rate of return and fixed principal value. U.S. Treasury bills do not eliminate market risk. The purchase of bonds is subject to availability and market conditions. There is an inverse relationship between the price of bonds and the yield: when price goes up, yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income.
The bullish percent indicator (BPI) is a market breath indicator. The indicator is calculated by taking the total number of issues in an index or industry that are generating point and figure buy signals and dividing it by the total number of stocks in that group. The basic rule for using the bullish percent index is that when the BPI is above 70%, the market is overbought, and conversely when the indicator is below 30%, the market is oversold. The most popular BPI is the NYSE Bullish Percent Index, which is the tool of choice for famed point and figure analyst, Thomas Dorsey.
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