When was it, a week ago? We were waxing worriedly (enough alliteration) about the resistance right above us for the major market indices. Well, that is all pointless now as we’ve technically broken out above resistance and made marginal new highs. The leader in this effort was the NASDAQ, which actually broke above its January highs a couple of weeks ago and now is clearly in new recovery high territory. All the hoopla about the NAZ being a big loser over the past ten years means nothing to this current run. It is all about “what have you done for me lately?” The NAZ has been the leader in this bull market and looks like it doesn’t want to give up the lead.
The NAZ had a top at 2326 back in early January and crossed over that level a good week ago with no fanfare at all, no recognition to be more correct. The NAZ is the vanguard of the large cap indices in this early bull market, watch them go.
The secondary issues, the mid-caps and smalls, are out in front on this advance. Both groups have been above January peaks for a couple of weeks. But, both areas had more severe pull-backs in February, so had more work to do to get back to even. (Reminds us of the old quote – “Where have they gone? I must hasten after them, for I am their leader.”)
The S&P 500 is in the next best shape. With its prior resistance at 1150 broken, if only barely, it looks to work higher in coming weeks. The prior highs ought to work as support on any pull-back from this rally in the weeks ahead.
The Dow is the laggard in all this. The Dow only Wednesday broke above its prior recovery high just above 10,730. The Dow needs to show some strength. As the most ‘quality’ focused of the indexes, it is the standard bearer of the current macro-play that quality is under-priced and ought to do better. (We are also on the verge of a new Dow Theory buy signal according to some folks. These are almost always controversial as there really are no clear rules on Dow Theory stuff.)
That said, technical analysis is always a history lesson and is not as predictive as its many adherents would like us to believe. We may have increased our odds of not having to go back to the February lows, but we may also have not changed anything. Any responsible technician, and that is not a contradiction in terms, would tell you that all you can count on with technicals is slightly improving your odds. They can not tell you where the market is going, just where it has been. The credo “in price there is knowledge” says nothing about what that knowledge can be used for.
Our valuation work argues that small cap is over-valued. But, try telling that to the legion of small cap aficionados who would rather underperform in small caps than own the leaders. If the new outlook of large cap leadership is correct, and we certainly hope it is, then the large caps have to show persistent strength in this rally and have to hold more of their gains in the next correction. That has been the case of most of the wiggles in the market so far, but you can’t count on that happening every time.
All this brings us to the point of this exercise – Where do we go from here? It is funny that in 6 months, 12 months, 18 months, new highs will be greeted with calls for more new highs, with excitement, with bullishness. Now, new highs are greeted with hand-wringing that stocks are once again ahead of themselves. Horse pucky! Large cap stocks are cheap, mid-caps are cheap. They will stay cheap as long as the fundamentals stay intact or get better (most likely scenario) and yields stay low (also highly likely in the short-run). We have a long way to go before these stocks are overvalued. If we even remotely are correct about the outlook for earnings, we could be at new all-time highs for the Dow and S&P 500 within a year and still be fairly cheap. All that needs is for earnings to increase at the currently expected pace and for rates to not rise too far too fast. We’ll have to wait and see if that actually turns out to be the reality we’ll face in a year or so. But, even with some upward rate pressure, earnings will drive stocks over the near term.
We have seen very little increase in bullishness on these new recovery highs. The ‘wall of worry’ that the market likes to climb is still in tact. That is good for our outlook.
Crisis of the Week
Official Chinese complaining about their consumers’ yen for imported goods has got folks worried. Though the Chinese complaint was specifically about imported luxury goods and was painted in revolutionary symbols or thrift and sacrifice, the call was seen as a warning to all importers who look upon the Chinese market as the next frontier in marketing and profitability. Technology products, media, consumer goods and capital goods are all in high demand in China, but the foreign nameplates exporting billions in profits back to home countries has made the Chinese government unhappy. Join the club.
In a world where just about every nation wants to grow by increasing exports, there is an increased urgency about buying domestic. Isn’t a Chrysler a better deal than a BMW? Hah! Shouldn’t we buy a US produced television rather than an LG? China has now joined the developed world in arguing to buy our own produce and employ our own people. So, today’s crisis is a warning to global trade.
Though the US talks a good game on free trade, our restrictions on imported goods, levies on imports and safety/security concerns make selling stuff here a real trial for many foreign companies. But, since this is where the money is, they put up with it. We are not as bad as the Japanese, who often have an almost patriotic belief that everything made in Japan is just better than stuff made everywhere else. Add to that the desire of the nation to be self-supporting in food and there are huge hurdles to exporters serving the Japanese market. Europe isn’t quite as bad, but between their desire to create jobs for their highly unionized workforces, pay for their welfare state and still make their consumers happy, tariffs and other duties on imports are very high to Europe.
Now, China is trying to join the club of defensive home market countries. Good luck. For a nation that now lives on exports, they have a lot more to lose than to gain by spitting on free trade. They are the unrivaled winners in free trade. They ought to see it for what it is and try to boost it, not bust it.
Perhaps the biggest barrier to global growth and progress is the ‘buy our own stuff’ movements across the globe. Going back to Adam Smith and David Ricardo, trade has always been the answer to advancing economically. Competitive advantage, natural endowment, or whatever you call it, not all nations are created equal in the stuff they are good at. The US is good at stuff that takes a lot of money or takes some ingenuity. We are also endowed with a very productive agricultural sector. So, we export grain, airplanes, advice and bonds. China has a huge labor force that is willing to work for pennies an hour. They produce all sorts of labor intensive products. That is competitive advantage. We sell bonds to China; they export the little toys in the Happy Meals to us. It works, don’t screw with it.
At its March FOMC meeting, the Fed decided once again to leave interest rates unchanged. They left their language about leaving accommodation in place for an ‘extended time’ in place as well. The Fed keeps harping on the idea that the economy is barely managing to keep its head above water even with all the monetary and fiscal stimulus. What is going to happen when they pull back from this, even a little? Nothing. The economy is just fine now that the crisis is past and the housing market has stopped falling at a break-neck pace. All we will get out of all the dovishness is a lot of inflation coming down the pike keep watching and it will show up eventually.
Industrial production rose in February despite the blizzard of 2010 and other issues. Factory output dropped due largely to a decline in auto output (thank you Toyota) but utility output and mining more than made up the slack. The gain of 0.1% was far higher than the drop of 0.2% that was expected. When will all these New Yorkers realize that there is more to this country, a lot more, than what goes on in their back yard?
Capacity utilization rose to 72.7% from 72.5% last month. We are watching capacity utilization as one gauge of slack in the economy in our inflation watch. Watch out for numbers that get a lot closer to 80%.
Housing starts fell in February by 5.9%. This is one time when the weather on the East Coast might have made a small difference. The decline was much smaller than anticipated by economists. Most of the change was in multi-family starts, apartments and condominiums, these fell by 43%. Single family starts slipped only 0.6%. Since the highs in starts back in 2005, the decline has been about 75%.
Producer prices fell by 0.6% in February, a much bigger drop than was expected. That was due largely to drops in energy prices, which fell 2.9%, mainly from a drop in gasoline prices of 7.4%. This does not jibe with our sense of what gas prices did last month, but we don’t have a good idea of what wholesale prices are for gasoline, only retail. Core prices, excluding food and energy prices, rose 0.1% for the month, in line with forecasts. For the past year, PPI gained 4.4% while the core was up 1.0%
Consumer prices were unchanged in February while the core reading of this index, which excludes food and energy prices, rose 0.1%. Energy prices declining lead to much of the ease in prices, but many areas are still exhibiting price pressures.
Leading indicators gained a whopping 0.1% in February. But, at least it was a gain, the eleventh in a row. When we stop wondering what the leading indicator is doing, that is when the economy is doing just fine.
The Reserve Bank of India raised it’s repo rate to 5% from 4.75%.
As mentioned above, the US large caps went to new recovery highs last week. That is only the beginning of the story. In the week, what has become the usual order of performance, the riskier the better, was reversed. The Russell 2000 actually fell a little bit while the Dow gained the most. This is the Dow playing catch-up while the Russell was jerked-around by the day to day swings in the market and felt the pain more and the joy less than the large cap stocks. Year-to-date the order is as you might expect, but the weeks don’t have to work the same way.
The international space was kind of opposite of the US with the lower risk developed markets losing a smidgen while the supposedly riskier emerging markets were higher. We say supposedly because many of the major emerging markets seem to be in much better shape than the old world leaders in Western Europe or Japan.
Bonds had another mixed week with the Treasuries gaining a smidgen, mortgages flailing around, high grade and high yield generally rising but munis mixed. International bonds were mostly okay, but for Japan, whose rates inexplicably rose. Maybe it had something to do with the general rising tide of Asian rates?
Real estate securities were mostly stronger in the US while weaker overseas.
Commodities were weaker on average with energy prices dropping, precious metals largely weak and not enough strength in any other area to offset.
Have a great week.
Karl Schroeder, RFC, CSA
Investment Advisor Representative
Schroeder Financial Services, Inc.