An Overview of The Markets
According to our methodology, Wall Street is currently in correction mode and this is not the time to invest fresh capital in stocks. It is notable that although major US indices advanced on Tuesday and Wednesday, volume was very low and this warrants caution. Moreover, volume picked up during Thursday's late stage sell-off and this negative action suggests that the ongoing stock market pullback may continue.
Given the recent weakness on Wall Street, we believe that investors/traders should keep their holdings on a tight leash and refrain from allocating fresh capital. For our part, we have recently been stopped out of a few positions and currently, approximately 30% of our equity portfolio is in US Dollar cash. Furthermore, we are protecting each and every open position with a trailing stop and should the market head lower, our stops will allow us to defend capital. At this stage, we cannot predict the depth or the duration of the ongoing correction, but given the loose monetary policy, Wall Street is likely to climb to new highs. In any event, as long as the market is in correction mode, we suggest a defensive posture.
In terms of specific sectors, it is worth noting that consumer staples and utilities are performing well, whereas some of the cyclical areas are coming under pressure. Such price action is typical of stock market corrections and until the uptrend resumes, the high-beta cyclical names will probably continue to feel the heat.
Over in the commodities space, the Reuters-CRB Index has weakened further and it is now trading well below the 200-day moving average. Furthermore, it is notable that the prices of copper and crude oil have also rolled over and it appears as though the sellers are in control. Contrary to what the 'hard asset' bulls may tell you, the truth is that aggregate global demand is currently weak and the world's reserve currency is strengthening. Therefore, this is not a favourable environment for commodities and we do not recommend exposure to this sector.
Looking at precious metals, it is becoming clear to us that both gold and silver put in major tops in 2011 and the onus now lies on the bulls to reverse the downtrend. As you will recall, we sold our positions last spring and since then, our advice has been to avoid this sector. Whichever way you cut it, the reality is that the price action in both gold and silver has been extremely disappointing and despite the ongoing QE-ternity, the selling pressure has overwhelmed the buyers! Look. If you review the price charts objectively, you will note that both gold and silver have formed a series of declining tops and they are currently trading well below the 200-day moving average. Needless to say, such price action is bearish and in our view, there is now a real risk that the prices of both gold and silver will fall below last summer's lows. If that happens, the secular bull-market will be over and prices will probably drift lower for several years.
At present, nobody knows whether last summer's lows will be breached, but the recent abysmal performance of the mining stocks suggests that next big move may be to the downside. Contrary to the bullish chorus of the 'gold bugs', the AMEX Gold Bugs Index has already sliced through last year's low and it is now trading at levels not seen since 2009. We are sure you will agree that any market trading at a multi-year low cannot be in an uptrend; thus this is not the time to have any exposure to the mining stocks. Yes, central banks are creating additional currency units and yes, monetary inflation is here to stay. Nonetheless, all this is yesterday's news and by now, 'stimulus' has already been discounted by the market. Thus, if you own precious metals and are convinced about your thesis, you should wonder why then, are prices falling?
Turning to currencies, the world's reserve currency is strengthening and the US Dollar Index has now climbed above its November high. By doing so, it has also broken through the 200-day moving average and the trend is up for now. Elsewhere, the charts reveal that the Australian Dollar, British Pound, Canadian Dollar and the Euro are weakening and with the exception of the single currency, the others are now trading below the 200-day moving average. Once again, although it is very difficult to make accurate predictions, it does appear as though the US Dollar is likely to strength over the following months and it is conceivable that we may be in the early stages of a multi-year rally. After all, the US Dollar Index fell by over 40% between 2001 and 2008 and today, most people are convinced that the world's reserve currency is a lost cause. Thus, bearing in mind the magnitude of the previous downtrend and the lopsided bearish sentiment, the stage may now be set for a big rally in the Federal Reserve's currency.
Over in the bond market, high yield credit has firmed a tad over the past week and we maintain our view that income-seeking investors should allocate some capital to this sector. Although rising interest-rates are a real threat to high-yield bonds, if these securities are held until maturity, this risk is removed from the equation. From our perspective, our US-Dollar denominated fixed income portfolio is still yielding approximately 6% per annum. Finally, it is interesting to observe that both German Bunds and US Treasuries have appreciated over the past week and it appears as though this recovery may continue over the following weeks.