The technicals were ripe for a correction…

Although the catatonic Greek state moved to the rearview mirror, it became painfully apparent that few were willing to forgive and forget.  By the end of last week, investors were left feeling deflated and in some cases, extremely queasy.  Recapping the numbers, the S&P 500 index closed down 6.4% and the Dow Jones Industrial Average was off 5.7%.  Below is a graph of the poor showing around the globe and we can see that only Gold and the US Dollar, classic flight to safety holdings, offered meaningful positive performance. 

 

Source: Wall Street Journal

Last week’s sell off was clearly resultant from a buildup of tension in technical factors coupled with overriding concern about the unfolding debacle in Europe. 

 

Numerous signs were flashing the caution light prior to last week.  The first being the VIX Index, a measure of stock market volatility, which traded near 15, close to levels last seen in 2007 and which was indicative of the growing complacency in the marketplace.  At the same time, institutional investors began to move away from equities while retail investors were becoming more bullish.  The State Street Investor Confidence Index, a measure of institutional equity exposure, fell to 99.7 in April, the lowest level since March of last year. 

 

Source: State Street Global Advisors

 

In addition, a recent asset allocation survey from the American Association of Individual Investors discovered that retail investors were increasing equity exposure, going from 59% to 61% in the most recent month, well above the 40% level in early 2009.  It is all too common that retail investors move into equities at the peak and back out at the trough.

 

Source: Pragmatic Capitalism

 

Before we hit the collective panic button, let’s consider the positives. 

 

Equity rallies move in a linear fashion.  That is, corrections are commonplace following a bear market and we should point out that this time around has been no exception.  Since reaching bottom in March 2009, the S&P 500 index experienced 5 corrections greater than 5%.  The first four proved to be attractive entry points for investors with an equity underweight. 

 

Source: Goldman Sachs

 

Perhaps even more surprising, during the 62%+ rally since March 9th of last year, investors have allocated virtually no money to equities, showing a higher predilection for the safety and assumed stability of bonds.  Even this year, only $2bln has made its way into equity securities, while another $116bln was funneled into bond strategies. 

 

Source: Goldman Sachs

 

… But what about the Fundamentals?

Although the technical factors were ready for a breakdown, a majority of the economic releases from last week suggest the recovery is still in its infancy. 

 

At the beginning of the week, the Federal Reserve Senior Loan Officer Opinion Survey indicated that banks eased lending standards for large and medium sized firms while holding standards steady for small firms.  Banks cited greater competition and a “more favorable or less uncertain” economic environment as the primary motivations for easing lending. 

Source: Federal Reserve

 

That was followed up at week end by the consumer credit report showing a $2.0bln expansion in consumer credit.  This was driven by growth in non-revolving credit (auto loans, primarily) while consumers continued to pay down credit cards by roughly $3.2bln.  The overall growth in credit came at the expense of the personal savings rate, which retreated to 2.7% in March, bucking economists’ belief that consumers would naturally be inclined to save more considering the severity of the recent recession.

 

 

Source: Econoday

 

News on manufacturing was equally as positive with the ISM manufacturing index rising to 60.4% in April, the highest level in nearly 6 years.  A jump in new orders is compelling firms to increase hiring and production, another positive sign of future growth.  The one area of concern is the prices paid index, currently at 78.0 from 32.0 only one year ago.  A whopping 60% of firms reported paying higher prices over the past month and only 4% of firms indicate that prices paid were in decline.  Across the spectrum, price increases were reported in 20 of 21 commodities.

Source: Federal Reserve Bank of Cleveland

 

The featured release of the week was the jobs report, which contained a number of interesting developments, from 290k jobs added to the economy to a 0.2% increase in the unemployment rate (9.7% to 9.9%). 

 

Source: Econoday

 

The 290k jobs created handily beat expectations and roughly 66k of those jobs was the direct result of temporary Census hiring, but 231k came from the private sector, a very bullish development.     

 

As a result of the improving economy, many of the unemployed who gave up searching for a job are gradually returning, causing the unemployment rate to rise to 9.9%.  The corollary was an increase to 17.1% in the “marginally attached” rate (those working part-time despite a desire for full-time employment and individuals who ceased looking for a job). 

Source: Haver Analytics

 

Other positive surprises from the report included higher average weekly hours and a very slight uptick in the average hourly earnings figure.  In the past 12 months, hourly earnings are up at a 1.6% pace, roughly half the pace of one year ago, creating strongly disinflationary headwinds that bear watching closely. 

 

Somewhat troubling, although hardly a new development, are the reported 6.7mln people who have been unemployed for longer than 27 weeks.  That equates to 46% of all unemployed individuals and the average duration of unemployment stands at 33 weeks. 

 

Since the official start of the recession in December 2007, the economy lost 7.8mln jobs.  In order to recoup those losses, we need to see 27 consecutive months of job growth around the 290k mark, an onerous hole that reminds us how severe this recession truly was. 

 

Goldman Sachs described it best last week when the firm said “the base case for the US economy has clearly improved, but so has the risk of a worst case outcome given the renewed turmoil in the financial markets.”

Source: Goldman Sachs

 

The market succumbed to a number of pressure points last week, but we should be cognizant of the continued improvement in the domestic economy.  Medium term prospects for domestic growth are encouraging but continued flair ups, such as the sovereign crisis in Europe, remind us that complacency is hardly an effective investment philosophy in times such as these. 

 

The week ahead

Investors should brace for another volatile week following the announcement that Europe will ready nearly $1trln to bolster its capital markets.  Attempting to understand the consequences behind such a maneuver is virtually impossible and will drive a large portion of the market action this week. 

 

The economic calendar in the US is moderately busy this week.  Wednesday’s announcement of the trade balance will be closely watched and is likely to show a widening based on higher oil costs.  Also of note is the April retail sales figure to be released on Friday.  Acceleration in job growth is expected to prove supportive but an early Easter pushed holiday-related sales into the prior month. 

 

The Treasury Department is returning to the market with $38bln of 3-yr notes (Tuesday), $24bln of 10-yr notes (Wednesday) and $16bln of 30-yr bonds (Thursday). 

 

Within the corporate sector, there are several companies left to report.  These include MBIA, Tyson Foods, InterContinental Hotels Group, Natixis, Toyota, Walt Disney, Allianz, Cisco Systems, ING, Macy’s, Nissan, Sony and EADS. 

 

The World Agricultural Forum meets in Brasilia Wednesday through Friday.  Up for

discussion are water issues, Latin America’s role in the global agriculture business and the affect of population growth on global food and fuel demand.    

 

Source: New York Times

 

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