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Prieur Perspective: Risky Assets Soar -- But Pullback Long Overdue


Transition from recession to recovery has markets, commodities peaking.

Risky assets last week again marched higher to the tune of economic data supporting the argument of a global economic recovery. A realization among investors that the economic transition from recession to recovery was gaining momentum resulted in many global stock markets and commodities scaling fresh peaks for the year.

The S&P 500 Index closed the week above the psychological 1,000 level, marking its highest level since November and capping 4 consecutive weeks of gains. And more upside lies ahead, said Abby Joseph Cohen, Goldman Sachs' (GS) market strategist, who expects the Index to reach the 1,100 point by year end. (Is this a contrary indicator coming from a permabull?)

Many commodities, such as crude oil, copper, aluminum, nickel, lead, and zinc hit their highest levels of the year, not to mention sugar recording a 28-year peak. "The financial crisis has been addressed, the commodity crisis has not," warned Goldman Sachs (via the Financial Times), predicting that this year's rise in prices was "just the beginning" of another rally that was "ultimately likely to be even more extreme" than those seen in the past. However, the Baltic Dry Index -- a measure of freight rates for iron ore and bulk commodities that correlates very well with base metal indices -- has broken technical support on the downside and short-term weakness in metals prices looks likely, possibly as a result of the Chinese buying-frenzy having come to an end.

While high-yielding commodity-linked and emerging-market currencies were in favor, the US greenback dropped to its weakest level since October before staging a rally on Friday after the announcement of the US employment data had pleased some traders (see comments in the "Economy" section below). Government bonds (with the exception of emerging markets) again sold off as the bond vigilantes cottoned on to the improved economic outlook.

The past week's performance of the major asset classes is summarized by the chart below -- a set of numbers that indicates continued investor appetite for risky assets (albeit with investment-grade and high-yield corporate bonds taking a breather).

A summary of the movements of major global stock markets for the past week, as well as various other measurement periods, is given in the table below.

The MSCI World Index (+1.8%) and MSCI Emerging Markets Index (+1.1%) both made headway last week to take the year-to-date gains to +15.5% and an impressive +50.4% respectively. The US and other markets extended their rallies to 4 straight weeks in most instances, although some weakness crept in among developing countries such as China, India, Singapore, and Taiwan. It's also noteworthy that emerging markets underperformed developed markets for the first time since the beginning of May. Could this be a first sign of a retrenchment in risk appetite?

Stock market returns for the week ranged from top performers such as Bulgaria (+15.5%), Romania (+8.3%), Lithuania (+8.2%), Kazakhstan (+8.1%), Estonia (+8.0%), and the Czech Republic (+7.1%). These are all Eastern Europe countries playing catch-up as pundits came to the conclusion that the initial doomsday scenario for the region's debt situation wasn't as bad as predicted. At the bottom end of the performance ranking, countries included Malta (-5.8%), China (-4.4%), Singapore (-4.1%), Côte d'Ivoire (-3.9%), Greece (-3.6%), and India (-3.3%).

After almost doubling since the beginning of the year and notching up 7 straight weeks of gains, the Chinese Shanghai Composite Index declined by 4.4% last week -- its worst performance for 5 weeks. The Index has broken its first level of support and it wouldn't come as a surprise if lower Chinese equities serve as the catalyst for a pullback in global stock markets.

No positions in stocks mentioned.
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