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Prieur Perspective: New Appetite for Risk


Investors turn to equities; commodities like oil, precious metals.


Government bonds dominated action on financial markets during the past holiday-shortened week, as angst about inflation and massive issuance propelled yields to 6-month highs in the US, Europe, and Japan.

Bonds and other safe-haven assets such as the US dollar were out of favor as signs of a bottoming of global economies, albeit tentative, emboldened investors' appetite for reflation trades like equities and commodities - including oil and precious metals.

In addition to the major stock-market indices rising for a third consecutive month, some of the other milestones achieved during the past week were the following:

  • The S&P 500 Index rose by 5.3% in May for a 3-month performance of +25.0% - the biggest 3-month gain since August 1938.

  • The Dow Jones Industrial Index advanced by 4.1% and 20.4% for May and the 3-month period respectively - its largest 3-month return since November 1998. (The last straight 3-month gain was from August to October 2007, when the Index reached its bull-market peak).

  • The US dollar declined to a 5-month low against the euro, losing 6.6% during May. The buck's decline was even more pronounced against high-yielding currencies such as the Australian dollar (-9.4%) and the New Zealand dollar (-11.3%).

  • The yield spread between 2- and 10-year Treasury Notes reached a record 275 basis points on Wednesday before narrowing to 254 basis points by the close of the week.

  • The Reuters-Jeffries CRB Index increased by 13.8% during May - its best monthly gain since 1974.

  • The Baltic Dry Index -- measuring freight rates of iron ore and bulk commodities -- climbed every day in May to post its biggest monthly advance (+95.6%) on record.

  • The price of West Texas Intermediate Crude recorded its largest monthly increase (+29.7%) since March 1999.

  • Silver surged by 26.8% for the month - its strongest performance for 22 years. (Gold bullion advanced by 10.2% during May, and platinum by 8.2%.)

Back to long-term bonds. According to the Financial Times, Mike Lenhoff, chief market strategist at Brewin Dolphin Securities, said:

"Bond markets may be telling us to expect inflation but, more importantly, I think they are telling us that policy makers the world over will succeed with their efforts to reflate the global economy.

"The trend of yields on corporate debt has been down, and that on Treasuries up, implying diminishing risk premiums - which is just what you would expect if markets are banking on recovery."

The week's performance of the major asset classes is summarized by the chart below.

The MSCI World Index (+1.7%) and the MSCI Emerging Markets Index (+6.6%) last week added to the previous week's gains to take the year-to-date returns to +5.4% and a massive +36.3% respectively.

Although the major US indices experienced declines on Monday and Wednesday, the weekly scoreboard ended in positive territory, as seen from the movements of the indices: S&P 500 Index (+3.6%, YTD +1.8%), Dow Jones Industrial Index (+2.7%, YTD -3.1%), NASDAQ Composite Index (+4.9%, YTD +12.5%) and Russell 2000 Index (+5.0%, YTD +0.4%).

The Dow remains the only major US index still in the red for the year to date, and along with the FTSE 100, one of the few global indices in this unenviable position.

As far as non-US markets are concerned, returns ranged from top performers Macedonia (+10.8%), Croatia (+10.2%), Nigeria (+9.9%), Namibia (+8.5%) and Peru (+7.8%), to the Czech Republic (-6.6%), Denmark (-5.7%), Saudi Arabia (-4.4%), Latvia (-4.2%) and Côte d'Ivoire (-3.5%), which experienced headwinds.

(Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

Emerging markets (especially the BRIC countries) are showing mature markets a clean pair of heels, as can be seen from the rising trend line of the MSCI Emerging Markets Index relative to the Dow Jones World Index since late October. The fact that developing countries are outperforming the developed ones is a sign that global investors are taking more risk - a necessary ingredient for stock markets in general to show a further improvement.

John Nyaradi (Wall Street Sector Selector) reports that as far as exchange-traded funds (ETFs) are concerned, the leaders for the week included Claymore/Delta Global Shipping (SEA) (+10.5%), iShares MSCI Hong Kong (EWH) (+10.4%) and HOLDRS Merrill Lynch Market Oil Service (OIH) (+10.4%). Poor performers were all things "short," with notable laggards being ProShares Short MSCI Emerging Markets (EUM) (-4.5%), ProShares Short QQQ (PSQ) (-4.1%) and ProShares Short Russell 2000 (RWM) ( 3.5%).

Further confirmation that the various central bank liquidity facilities and capital injections are having the desired effect of unclogging credit markets, comes from the Goldman Sachs' Financial Stress Index (FSI). This index includes 4 factors related to the degree of impairment of financial markets: counterparty risk (US dollar 3-month LIBOR-OIS), liquidity risk (mortgage-backed security [MBS] to treasury repo differentials), refunding risk (commercial paper outstanding) and broader risk aversion (percentage of monies held in money-market mutual funds in relation to equity market capitalization).

As shown in the graph below, the FSI is now at its lowest level since the beginning of the credit crisis in August 2007.

The decline of the US dollar and the rise in bond yields took on new momentum during the past few weeks. Deepening anti-dollar sentiment caused bets against the greenback on the Chicago Mercantile Exchange to rise to their highest level since the onset of the financial crisis, reported the Financial Times.

Richard Russell (Dow Theory Letters) said:

"The US Dollar Index is sitting on what I term 'the edge of the cliff.' If the dollar falls apart, we're dealing with a whole new story - it will affect almost all investments, US and foreign. The sliding dollar is already putting pressure on Treasury bonds, particularly the long-term maturities. This is causing our creditors (think China) to cut back."

The graph below shows that the sovereign debt bubble may be in the midst of bursting.

The higher Treasury yields had a negative impact on mortgage rates, with the 30-year fixed rate increasing by 29 basis points to 5.27% on the week, and the 15-year fixed rate by 25 basis points to 4.87%, as indicated by Yields on mortgage bonds for the first time exceeded the levels at which they were trading before the Fed's announcement of expanding Treasury purchases to reduce lending rates. This raises the question of whether the Fed might soon increase its Treasury buy-backs.

The quote du jour comes from the "out-the-box" analyst Marc Faber, who argued that the US economy would enter "hyperinflation" approaching the levels in Zimbabwe. "I am 100% sure that the US will go into hyperinflation," Faber said in an interview with Bloomberg. "The problem with government debt growing so much is that when the time comes and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate."

In other news, according to The Washington Post, senior administration officials are considering the creation of a single agency to regulate the banking industry, replacing a mishmash of bodies that failed to prevent banks from plunging into the worst financial crisis since the Great Depression.

Zeroing in on the US stock markets, this week's survey of investor sentiment from the American Association of Individual Investors (AAII) shows an increase in both bearish and bullish sentiment. Bespoke reports that in the last week, bullish sentiment increased from 33.7% to 40.4%, whereas bearish sentiment climbed from 45.4% to 48.6%. Bears, therefore, still outnumber bulls, and are at their highest level since March 12.

An analysis of the moving averages of the major US indices shows all the indices above their 50-day moving averages, with the NASDAQ Composite after last week's gains now also above the key 200-day line and the early January high. The highs of May 8 (already breached by the NASDAQ) are the most immediate targets to the upside, whereas the levels from where the rally commenced on March 9 should hold in order for base formations to remain in force.

Eoin Treacy (Fullermoney) said:

"... the logical areas for indices to encounter resistance are near round numbers. For the S&P, this would be 950 or 1,000. The FTSE 100 is currently encountering supply beneath 4,500. For India, 15,000 is the pertinent number. Brazil is currently in the region of 53,000, and if it breaks upwards from here, the next logical area for people to look at is 60,000."

Adam Hewison of has again prepared another of his popular technical analyses - this time on the British pound, oil, and gold bullion. Click here to access the short presentation.

Richard Russell, who has taken the stand that we're experiencing a bear market rally, said:

"Lowry's valuable statistics have been available for over 70 years. Normally, as a bear market nears its final low, Lowry's Selling Pressure Index sinks dramatically, thereby providing evidence that the supply of stocks for sale is sinking. The Selling Pressure Index continues to decline after the bottom has passed. This is NOT what has happened before or since the March 9 lows.

"On the low of March 9 Lowry's Selling Pressure Index stood at 884. At yesterday's close the Selling Pressure Index stood at 868, only 14 points lower than it was on March 9. Meanwhile, on March 9 Lowry's Buying Power Index stood at 120. At yesterday's close, Buying Power was at 156, which was a gain of 36 points from the March 9 low.

"To move the stock market higher in a healthy way, Buying Power must rise while Selling Pressure must decline. As things stand, there's still too much Selling Pressure (supply) built into this market."

With the first-quarter earnings reporting season now winding down, analysts are shifting their focus to the second quarter. Albert Edwards, Société Générale's strategist, observes (via Barron's) that bottom-up company analysts forecast an unprecedentedly mild contraction in profit margins in the midst of the worst recession since the Great Depression. "This just doesn't make sense to us. Analysts are 'anchoring' on recent unprecedented highs in margins as the new norm, instead of viewing them as bubble nonsense never to be seen again." Time will tell whether the consensus earnings expectation for the S&P 500 of a 34.7% decline for the second quarter of 2009 versus the second quarter of 2008 is too optimistic.

As General Motors (GM) moved closer to a bankruptcy filing, possibly on Monday, I couldn't help recalling the statement by former GM CEO "Engine Charlie" Watson: "What's good for the country is good for General Motors, and vice versa." Oh well.

For more discussion on the direction of stock markets, also see my recent posts Video-O-Rama: Higher Bond Yields Raise Caution, Why Jeremy Grantham Changed His Mind, Dollar's Slide Hurting Foreign Investors, Goldman: Past the Worst? and Technical Talk: S&P 500 Testing Resistance. (Also, Donald Coxe's webcast has been updated for May 28 and makes for good listening. This can be accessed from the sidebar of the Investment Postcards site.)


I regularly post short comments (maximum 140 characters) on topical economic and market issues, web links and graphs on Twitter. For those not doing so already, you can follow my "tweets" by clicking here. The Twitter posts also appear on my Facebook page and in the sidebar of the Investment Postcards site.


"Sentiment among global businesses remains very poor, but it continues to slowly improve. Confidence has moved measurably higher since mid-March and is now close to where it was last November. Businesses are notably more upbeat about the outlook towards the end of this year ...," said the latest Survey of Business Confidence of the World conducted by Moody's The global economy remains mired in recession according to the Survey results, but the recession is becoming less intense.

"Taken separately, one can find many reasons not to rely on survey results, especially those from consumers. But put them together, and global survey results indicate that economic stabilization is afoot," said Rebecca Wilder (News N Economics).

As seen from the chart below, the consumer and business survey results for the US, Japan, and Germany have been improving for several months now, with the US showing a sizeable increase in May. The Eurozone has just seen its first improvement in economic sentiment since May 2007.

Considering hard data, signs have also emerged that the global economy is stabilizing. Examples include a rebound in Japanese industrial production, the first rise in German retail sales in 4 months, and a rise in UK house prices in May.

Turning to the US, a snapshot of the week's economic data is provided below.

May 29

First-quarter real GDP preliminary estimate - minor revisions, message is unchanged

May 28

  • New Home Sales flat in April, inventories are shrinking slowly
  • Jobless Claims fall but continuing claims continue to advance
  • Durable Goods Orders were weak in April, Defense Orders lifted total bookings
May 27

Sales of Existing Homes moved up, but inventories remain elevated

May 26

  • Chicago National Activity Index sends an upbeat message
  • Consumer Confidence Index posts significant jump in May
  • Case-Shiller Home Price Index - noteworthy price movements, but more is required
Referring specifically to US housing, Minyanville Professor John Mauldin said:

"Housing in many areas is starting to once again become affordable (see chart below) to more and more Americans and even first-time home buyers. The cure for the housing crisis is actually lower prices, as that brings more and more potential home buyers into the market. While housing sales are still quite depressed, what are selling are homes in foreclosure, as buyers perceive that there are bargains. And they are right."

In his weekly Forbes column, Nouriel Roubini (RGE Monitor) commented as follows:

"The crucial issue facing us is not whether the global economy will bottom out in the third or fourth quarter of this year, or in the first quarter of next year. It's whether the global growth recovery, once the bottom is reached, will be robust or weak over the medium term - say 2010-11. ... one cannot rule out a sharp snapback of GDP for a couple of quarters, as the inventory cycle and the massive policy boost lead to a short-term growth revival. My analysis, however, suggests that there are many yellow weeds that may lead to a weak global growth recovery over 2010-11."

On a related note, Gillian Tett (Financial Times) asked whether one should expect a "V"-shaped recovery, or a scenario more like a "U" or a "W."

"Many years ago, when I was a rookie reporter, I learnt the Pitman system of shorthand. And it just happens that the half-squashed, asymmetrical 'W' pattern that I am struggling to describe is almost identical to the shorthand sign for 'bank.'

"So there you have it: as long as we avoid a government bond crisis, my best prognosis is for a 'bank' shaped recovery-cum-stagnation, at least as depicted by shorthand. It is a fitting twist for a crisis that started with the shadow banks; perhaps the Gods of finance (and journalism) have a sense of humor after all," said Tett.

Week's Economic Reports

Click here for the week's economy in pictures, courtesy of Jake of EconomPic Data. Click here for a summary of this week's economic calendar from Yahoo.

In addition to Federal Reserve Chairman Ben Bernanke's testimony before the House Budget Committee (Wednesday, June 3), and interest rate announcements by the Bank of England and the European Central Bank (Thursday, June 4), the US economic highlights for the week include the following:


The performance chart obtained from the Wall Street Journal Online shows how different global financial markets performed during the past week.

British philosopher Bertrand Russell said:

"If a man is offered a fact which goes against his instincts, he will scrutinize it closely, and unless the evidence is overwhelming, he will refuse to believe it. If, on the other hand, he is offered something which affords a reason for acting in accordance to his instincts, he will accept it even on the slightest evidence."

That's the way it looks from Cape Town as May draws to a close.

No positions in stocks mentioned.
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