The markets are in the “bad news is good news” mode, meaning that the poor employment report of Friday, showing private sector job gains remain very weak, would increase the likelihood that the Fed would continue injecting money into the financial system. So sure that stocks will continue to levitate, investors snapped up equities of all stripes, pushing stocks to their best levels in five months. If and when the economic data begins to turn significantly for the better, the financial markets will be looking for a bailout from the Fed pumping liquidity (money) into the financial system. Other data last week that bolstered stocks included a service sector that remains in expansion mode and pending home sales moved slightly higher. The flipside is a very weak dollar, with countries seemingly fighting each other for the right to devalue their currencies. The weaker dollar is also impacting commodity prices, as not only gold, but also grains and oil continue their march toward high ground. In fact, the commodity index is up over 20% vs. a year ago level and on a trajectory toward the peak made in early July 2008. Here’s hoping the news continues to be bad!
Now that stocks have jumped for five of the past six weeks, investors are getting much more comfortable with equities, as bullish sentiment has increased to levels not seen since mid-May, just before stocks took a bit of a breather from touching 1200 on the SP500. While that level may be once again touched in the weeks ahead, the seeds are being sown for another correction as investors begin gathering on one side of the market boat. What seems to be different with any correction that may occur is the Fed has announced they will be at the ready to provide extra money for the financial system. Today, investors are betting upon that additional “quantitative easing (QE)” hitting the markets at the Fed’s next meeting in early November. Other longer-term momentum indicators are breaching levels that have historically preceded market declines. So while a correction may occur, it is likely to be short and shallow – unless the Fed indicates they will withhold from embarking upon QE (or does so at a reduced rate). In the meantime, earnings will take center stage and comments upon business conditions will be in focus for the next couple of weeks.
Interest rates across the yield curve are once again plunging toward zero. How low is low? The two-year government yield is 0.35%, so an investment of $10,000 earns $35/year – hardly worth making the investment. If you loan the government your hard earned money for five full years, you can still get paid just above 1% per year. Five years ago the yield was a paltry 5%. Given the comments from the Fed regarding QE, bond investors are figuring the Fed will be a ready buyer of bonds, keeping rates low (or falling) through the rest of the year and into early 2011. What is not clear is the impact of a lower dollar and higher commodity prices ultimately upon bond prices. If fears of an inflation cycle, which the Fed is trying to induce, were to take hold, rates would rise dramatically from currently low levels.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.
