Regardless of whether or not you currently find yourself in the bull or bear camp, I think most any objective observer of the financial markets over the past two weeks must concede that risks are rising. While nothing as cataclysmic as the collapse of Lehman Brothers is yet seen as likely (though the sovereign debt concerns out of Europe and Dubai are certainly moving in that direction), there have been areas of concern cropping up around the world. Whether it be the ultimate effects of the Federal Reserve’s QE2 actions, escalating default concerns related to European governments, or heightened concerns over a global currency/trade war, the fact is that we’re getting a steady trickle of negative news that is not confined to a single region, country, or asset class In yet another example of these developments, news out of Asia overnight brought to light concerns over the actual level of inflation being seen in China as well as additional monetary tightening actions that are likely to be undertaken. Though Chinese leaders dismiss the inflation data concerns as nonsense (How shocking is it that a Chinese government official doesn’t view criticism as credible?), the larger inflationary story was enough to send Asian equity markets reeling and, thereby, pressure U.S. and European markets early in today’s session.
So with this larger view of the economic environment in mind, I find myself asking how this increased trepidation will affect the markets in the coming weeks. My read is that the equity markets are set up for a stagnant November and December with a slight downward bias. This outlook stems from a few cross currents that are currently rippling through the marketplace. First, on a historical basis, this time of year is the most bullish period for stock prices. Both the S&P 500 and the NASDAQ display their highest average returns in these two months, which suggests that there is an inherently bullish bias at this time. Part of this is likely due to institutional investors (fund managers) chasing returns prior to year’s end as well as shrinking volume levels associated with smaller participation around the Thanksgiving, Christmas, and New Year’s holidays. However, one of the reasons why this period of time tends to be so positive, aside from the reasons I just mentioned, is that share prices have tended to fall during the August/September period. This puts the equity market in a relatively oversold condition that provides an opportunity for investors to buy shares at lower values, which allows more room for an upside rally. Unfortunately, this was not the case in 2010 as September saw the largest monthly rally since the 1930s and the major indexes are up about 15% since their July lows. In my opinion, this countertrend rally should somewhat negate the upward seasonal bias that would be expected at year’s end. Last, but not least, bullish equity investor sentiment has likely peeked for the time being. A recent survey from AAII noted that over 50% of individual investors have grown bullish on stocks as an investment asset. To be sure, this is a dramatic change from the recent past, but, more importantly, it shows that investors are coming into a seasonally strong period of time in a rather jubilant mood. As such, the ability of retail investors to grow significantly more bullish over the next few weeks (especially in light of the negative data points are coming out daily) is probably not likely. This, again, keeps a lid on any rally and gives the market the downward bias I’m looking for.
Keep an eye on gold today. The yellow metal has been trading quite impressively all week (from the bullish perspective), but has seen decent selling so far in the early going this morning. Again, I remain skeptical of gold’s ability to continue its rally from current levels, but the fact is that the price action has been nothing short of resilient; much to my surprise and chagrin. However, the fact that it is trading lower despite some slight weakness in the U.S. Dollar so far today is at least some solace that my short gold thesis could still work out. Outside of this, how the U.S. Dollar closes out this volatile week will be worth noting. Having pushed back above some technically critical levels in spite of negative commentary and the Fed’s actions, holding most of the week’s gains would be a big win for Dollar bulls. So far today, it appears as if this will prove to be the case.
Lastly, I want to apologize for not getting any evening comments up last night. My sister-in-law has been in the midst of a high-risk pregnancy that culminated in an emergency c-section last night. Thankfully, both Pamela and my new niece, Kyndal, came through the procedure just fine, though Kyndal will be in the Lubbock NICU for a while since she wasn’t due for another six weeks and needs help to fully develop her lung function. Needless to say, both Stacy and I were consumed with everyone’s condition last night, hence my lack of commentary. While I should have a normal post up this evening, I wanted to ask you all to keep both Pamela and Kyndal in your prayers as they work through this trying time. Anyone who has ever been a party to a situation like this knows how fragile this time is, so they could use any and all help you can offer. I’ll be sure to keep you all updated on where things stand. Thanks to you all.
Until later…..
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