That was quick!

Well that was certainly a quick correction!  Score one for the Fed and its liquidity wave.  Less than a 3% drop in the S&P 500 was all it took and the buyers came in and have taken us to within 2.5% of the all time highs. 

Source: StockCharts.com

Meanwhile, the narrower, but better known Dow Jones Industrial Average has broken out to new highs this morning.  The media is all over it.  Even the relatively staid Wall Street Journal is in on the act with this little feature in the middle of its online page:

Source: Wall Street Journal 3/5/13

The Dow's breakout to new highs will undoubtedly attract a lot of attention from both the financial and mainstream media.  Given the relentless drumbeat of negative economic news in the media, this may come as quite the shock to many people.  It becomes clearer, when you remember that the main driver of media is to sell either ads or subscriptions.  Hype, outrageousness and promotion are all part of the playbook to get your attention and sell ads.  A good summary is posted on the site Abnormal Returns.  Keep this in mind as the media hypes the new highs theme. 

 

In the meantime, as has been noted here and elsewhere, the negative factors affecting the global economy keep piling up (fiscal cliff deal, sequester, gas prices, Italian elections, etc.).  Adding to that list, the Shanghai Composite broke through its 50 day moving average.  This is important for two reasons.  First is that over the last few years, the Shanghai Composite has been somewhat of a leading indicator.  Second, it comes in response to China's renewed attempts at cooling its property market.  Anything slowing down one of the few engines of world growth is not a positive.

Source: Bespoke Investment Group

Keep all of this in mind as the you watch the market the next few days.  It will be extremely tempting to change your plan or add more risk to your portfolio than intended.  In many ways it is natural to get caught up in all of the excitement.  The key however, is to stick to whatever long term plan you made in more peaceful times.  Remember, purely emotional decision making is the enemy of good investing.  In the meantime, stick to the plan, hang ten and enjoy the ride!

Garrett McNamara riding an approximate 100 foot wave.

Source: Guardian

 

President's Day Update

I hope everyone had a good weekend and is enjoying the added day of market respite this President's Day.  Last week was mixed on the economic front.  On the plus side, housing inventory and unemployment claims both dropped in the US.  On the negative side, so did industrial production.  The big news was the return of M&A on a big scale, with Warren Buffett's Berkshire Hathaway taking Heinz private and American and US Airways coming together to form the world's largest airline.  For all of that, the S&P 500 Index was roughly flat for the week.

Looking ahead, this holiday shortened week has some interesting data points.

Tuesday:      German ZEW Survey         
Wednesday: US Housing Starts, PPI and Fed minutes, German and French CPI, Chinese Flash PMI
Thursday:    US Jobless Claims and CPI
Friday:         German GDP and IFO Survey
Sunday:       Italian elections

The two German surveys should give us insights into the state of that economy, as should the Chinese Flash PMI.  Here in the US, housing starts, Fed minutes and jobless claims will draw alot of attention.  With the Italian 10 year yield down 12 basis points (bps) YTD and spreads 45 bps tighter versus German bunds through Friday, the markets seem to anticipate at worst a neutral result to Sunday's Italian election, but we will need to see.  On Monday, the European markets did appear to get uneasy about the probable election results.  As they say, that is why they play the game.  

While the G-20 declared that they will refrain from competitive devaluation, there does seem to be a distinct benefit to a lower currency for ones stock market.



Both the UK and Japanese markets with their falling currencies are doing about ten percentage points better than Brazil with its strengthening currency, the real.  On Monday, with a seeming all clear from the G-20, the trend continued.  In Asia, the Nikkei was up over 2% as the yen fell to almost 94 to 1$US.  In South America, the Brazilian stock market (the Bovespa) fell another 50bps as the real rose against the dollar. 


On another front, correlations between various risk based asset classes have been coming down indicating some differentiation between them, as opposed to a blind risk on/risk off trading environment.  The chart below shows the trailing 24 month correlations between various asset classes as of 2/17/13 as represented by ETF's.  The red cells show high positive correlation.

Source: AssetCorrelation.com

The chart below shows the one month trailing asset correlations:



Source: AssetCorrelations.com

You can see how the dark red area has shrunk significantly, with even Emerging Market (EEM) correlations falling under 0.7 to the Real Estate indexes and the US stock market indexes.  While we are still subject to headline risk (Sequester, Italian elections, etc.) this is a healthy development as it indicates investors are differentiating more on the basis of each asset class' underlying fundamentals, rather than on the latest headlines.

Anecdotes vs. the Fed

As the S&P 500 Index nears its all time high of 1,565, anecdotal evidence of an imminent top keeps piling up.   This past weekend, the front page of the New York Times had an article on small investors getting back into the market.  CNBC has their little bugs in the bottom right of the screen with how many points to go to the all time high.  It is hard to find a bear on the major financial news outlets.  Bill Gross, Dan Fuss and Jeffrey Gundlach are moving into equity management.  (Okay maybe not this last one, since they are all smart guys and after all how much more can you squeeze out of bonds with the ten year Treasury around 2%?  But the others definitely qualify.)

Against this stands the Fed and many of the other central banks of the world.  By nailing short term rates to zero and doing their best to keep the rest of the yield curve as close as possible, they have been trying to force investors out on the risk curve.  As the Ned Davis chart below shows, it appears that they are finally succeeding.  After years of outflows, equity funds have experienced large inflows so far this year.

 

Source: Ned Davis Research

While there are many reasons that the market should not go up, it continues to defy the skeptics.  The main reason appears to be the unrelenting liquidity supplied by the Fed and now supplemented by individual investors.  It is apt that this week surfer Garrett McNamara possibly broke his own record by riding a an approximate 100 foot (30 meter) wave.

Source: Guardian



In many ways, staying invested in this market is similar.  Both are powered by huge amounts of liquidity, can take you a lot further than you think, it is an exhilarating ride, and can end either in glory or disaster. 

"You can't stop the waves, but you can learn to surf"
John Kabat-Zinn

 Learn to surf (investments).