Editor's Corner
Another Wild Week
Ron Rowland
It's been another wild week in the markets, although we are hard pressed to recall a recent period that wasn't considered wild. The latest bout of volatility centered itself in the commodity markets. Commodities have been the darling of the capital markets this past year as both stocks and bonds had their troubles. Prior to last week, commodities were performing so well that it was being called a bubble.
Many widely followed individual commodities are also dealing with big round number psychology. Gold touched $1000 per ounce, then dropped back below $900 before starting a fresh advance a few days ago. Crude oil broke the magic $100 level a few weeks ago and suddenly dropped below it again last week. Today, crude oil is trading at $105. These big round numbers always attract extra media attention, which adds to the volatility.
The current debate is whether or not a bottom is in place for the stock market. Many analysts are just now admitting a recession. The official arbiter -- the National Bureau of Economic Research -- is notoriously late and has even been known to declare a recession after the ensuing recovery had already started. The stock market is a discounting mechanism. It likes to look ahead. It is a leading indicator.
Widely-followed analyst Dick Bove went on record last week saying the bottom is in for financial stocks and that now is the best buying opportunity for the next 20 years. He could be right. So far, nearly every test of the market lows has met with failure and additional declines. The economy will likely get worse before it gets better. The stock market is another story, and it will start to recover before the economy does. There is a chance that the market recovery is already underway. Only time will tell.
Demand for short-term Treasury securities soared last week with the intra-day yield dropping to just 0.2% on Thursday. Those same securities are trading with a 1.3% yield today, well above last week's low but still much less than the Fed's target rate of 2.25%. The action was more muted for the benchmark 10-year Treasury yield, which hit an intra-day low below 3.3% last week and closed today at 3.5%. High-yield bonds gained traction last week but still present a high degree of risk.
Sectors
The steep sell-off last week in commodities and commodity-related sectors caused a shift in our sector rankings. Materials and Energy slipped out of the top two positions but still possess above-average momentum. Both sectors staged impressive rebounds the past few days. This now makes last week's brutal sell-off look like a buying opportunity. The Consumer Staples sector is often a top-performer in recessionary environments, so it's no surprise to see it back in the top position in our rankings. One of the characteristics of Consumer Staples is its below-average volatility. As such, we don't expect it to have the large swings that many other sectors exhibit. The Industrials sector has also moved into positive territory on the recent strength of the transportation and industrial equipment industries.
Styles
The dividing line between Small Cap Value and Micro-Cap styles can often be quite subtle. A quick glance at their respective charts shows similar patterns -- a topping-out during the second quarter of 2007, a multi-step decline since those tops, and recent lows occurring simultaneously on March 10. With that much similarity, one wonders why they are at opposite ends of our style rankings. This is where our relative strength analysis comes into play. Yes, both established new lows on March 10, but the low for Small Cap Value was only 1% lower than its January low. The new low for Micro-Caps was nearly 6% below its January low. Meanwhile, Small Cap Value is currently up nearly 8% from those January lows while the gain for Micro-Caps is only 2%. While their one-year charts may look similar, their actual performance has been quite different.
International
The commodity sell-off was evident in the international equity markets as commodity-sensitive areas such as Canada, Latin America, and Russia all suffered declines last week. However, these same markets are also enjoying a strong rebound this week along with commodities. As commodity markets declined, the US dollar gained strength. This in turn caused US markets to advance relative to the rest of the world this past week. Many analysts believe this is just a short-term blip and the dollar will resume its downtrend soon. If that is true, then international markets will once again have the currency translation advantage on their side.
Note:The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
