Although it wound up being a positive week for the market, it certainly didn’t feel that way at times as investors were treated to another dose of wild swings in both directions. But after struggling with losses during the prior two weeks, it was nice to see stocks get back on track as the Dow gained +3.20%, the S&P was up +3.20%, the Nasdaq popped +3.29%, and Russell increased by +3.12%..

To hear the media tell it, the fact that the Dow finished over 10,000 once again was the highlight of the week. While we weren’t deluged this time around with endless shots of smiling traders adorned in Dow 10K t-shirts and caps, we did hear an inordinate amount of chatter about something that, from where we sit, was completely irrelevant.

On this note, please allow me an additional moment of digression. From my perspective, it is disturbing to hear commentators, who, in the public's eyes, are considered to be market experts, going gaga over the Dow crossing above a big round number (again) without nary a mention of the fact that there is significant resistance lurking at the very same levels or that the volatility is causing distortions. (And am I the only one surprised to see CNBC’s Maria Bartiromo now pitching her very own market newsletter? What exactly is she going to help investors with – the best questions to ask during an interview?)

Not Passing the Buck

Stepping down off of the soapbox, one of the overriding themes of the action over the past couple weeks has been the marked increase in volatility. Intraday swings of 200 points are becoming more commonplace and oftentimes appear to occur for little reason. But, if you looked hard enough, you could usually tie the recent volatility to the movement in the dollar, as there has been a great deal of consternation leading up to the Fed meeting about the fate of the “dollar carry trade.”

With just about everybody and their grandmother short the greenback in the hedge fund community, traders appear to be getting a little nervous about interest rates rising in the U.S. or an increase in the dollar. As we’ve been discussing lately, the problem is an increase in the dollar and/or rising rates causes traders to cover their dollar short (or their dollar-based borrowings) and sell the “risk assets” (think stocks, commodities, and emerging markets) to close out the trade. Remember, due to the size of many funds, one of the big battle cries in hedgieland is to “sell when you can, not when you have to.” And this is especially true when trades like the “dollar carry trade” become overly crowded.

Despite the focus on the greenback and the resulting volatility, there were a number of positive developments for stocks including (1) upbeat reports from the manufacturing sector that helped to shift some of the focus back on the global recovery theme, (2) better-than-expected data from the economic calendar here at home, (3) the Fed's decision not to change their statement language and avoid any talk of an “exit strategy”, (4) a pickup in M&A activity, (5) the extension (and expansion) of the homebuyer tax credit and unemployment benefits, (6) victories for the Republicans in key governor races, (7) continued, albeit modest, improvement in the jobs picture, and (8) reduced expectations for aggressive healthcare reform.

Not Looking For the Exits (Yet)

Digging a little deeper, one of the positives this week was the paring of expectations surrounding the FOMC making changes to their policy statement. There was a lot of talk that the Fed might adjust or tweak the language in order to give the central bank some flexibility in terms of starting to shift away from their current ultra-loose monetary policy. But, in the statement accompanying the announcement that the Fed would leave its target range for the federal funds rate unchanged at 0%-0.25% on Wednesday, there was no such discussion or even the hint of an “exit strategy.”

In sum, the Fed cited improving economic conditions, low rates of resource utilization, subdued inflation trends and stable inflation expectations, and a consumer that is likely to remain less active than “normal,” as reasons they are likely to keep rates at exceptionally low levels for an extended period. And while we all know that the Fed will have to make a change at some point in the future, traders took solace in the fact that at least for now, Bernanke & Co. are not interested in pulling the punchbowl prematurely.

It’s the Economy, Stupid…

Looking at the economic calendar, although Friday's October Nonfarm Payroll report was highlighted by the worst unemployment rate (10.2%) since 1983, traders did take note of the fact that the jobs market continues to improve – even if it is at a painstakingly slow rate. Analysts noted that it was the upward revisions to both the August and September job loss totals that was responsible for the stock market roaring back after an early dive on Friday morning.

Speaking of economics, there were a number of other bright spots on the economic calendar this week that help to shift the momentum back toward the global recovery trade. In the US, much of the focus was on ISM Manufacturing Index, which posted its strongest reading since April of 2006. In addition, Pending Home Sales rose for an eighth straight month in September, Worker Productivity surged 9.5% in Q3, the biggest quarterly increase in six years and the four-week moving average for Weekly Jobless Claims fell for a ninth straight week. While none of the above are blockbuster reports, the combination helped provide a more upbeat mood.

Does the Market Have “Issues?”

Finally, while the bulls did come away with a win this week, we remain concerned about the volatility (often viewed as a precursor to a change in the direction of the primary trend) as well as the lack of internal momentum this week. For example, our momentum models failed to improve to any meaningful degree, the volume relationship was worrisome (the volume on the DJIA actually fell each day this week), and the former leaders (NASDAQ and Russell 2000) have lagged the Dow's dance to 10,000. So, while we did enjoy the pop to the upside, we remain concerned about the sustainability of the current move.

Remember, the recent run for the roses has been one of, if not the best rallies off of a bear market bottom in history. In the process, stock valuations have become stretched with most analysts pointing to S&P 1200ish as the upside target based on the current earnings expectations. Then when you factor in the punk expectations for consumer spending, the upcoming holiday shopping season, and the fact that earnings will need to become “real” sometime soon, it is easy to see that the market may not be able to continue to head higher ad infinitum without a meaningful correction.

Enjoy your weekend,

David D. Moenning
Founder TopStockPortfolios.com

Positions in Stocks Mentioned: None

 

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